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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think NTPC (NSE:NTPC) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for NTPC:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.083 = ₹281b ÷ (₹4.2t - ₹766b) (Based on the trailing twelve months to June 2022).
Therefore, NTPC has an ROCE of 8.3%. Even though it's in line with the industry average of 8.3%, it's still a low return by itself.
In the above chart we have measured NTPC's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering NTPC here for free.
How Are Returns Trending?
There are better returns on capital out there than what we're seeing at NTPC. Over the past five years, ROCE has remained relatively flat at around 8.3% and the business has deployed 62% more capital into its operations. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
The Bottom Line On NTPC's ROCE
In summary, NTPC has simply been reinvesting capital and generating the same low rate of return as before. Although the market must be expecting these trends to improve because the stock has gained 41% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
One final note, you should learn about the 2 warning signs we've spotted with NTPC (including 1 which is a bit concerning) .
While NTPC may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list 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.