Mahanagar Gas (NSE:MGL) Might Be Having Difficulty Using Its Capital Effectively

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, while the ROCE is currently high for Mahanagar Gas (NSE:MGL), we aren't jumping out of our chairs because returns are decreasing.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Mahanagar Gas is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.22 = ₹8.5b ÷ (₹51b - ₹13b) (Based on the trailing twelve months to December 2021).

Thus, Mahanagar Gas has an ROCE of 22%. In absolute terms that's a very respectable return and compared to the Gas Utilities industry average of 23% it's pretty much on par.

View our latest analysis for Mahanagar Gas

Historical performance is a great place to start when researching a stock so above you can see the gauge for Mahanagar Gas' ROCE against it's prior returns. If you're interested in investigating Mahanagar Gas' past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Mahanagar Gas' ROCE Trend?

When we looked at the ROCE trend at Mahanagar Gas, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 28%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

Our Take On Mahanagar Gas' ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Mahanagar Gas. These trends are starting to be recognized by investors since the stock has delivered a 3.7% gain to shareholders who've held over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

On a separate note, we've found 1 warning sign for Mahanagar Gas you'll probably want to know about.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.