Here's What To Make Of Reliance Power's (NSE:RPOWER) Decelerating Rates Of Return

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. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Reliance Power (NSE:RPOWER) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Return On Capital Employed (ROCE): What is it?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Reliance Power is:

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

0.062 = ₹21b ÷ (₹502b - ₹163b) (Based on the trailing twelve months to September 2021).

Therefore, Reliance Power has an ROCE of 6.2%. Even though it's in line with the industry average of 6.3%, it's still a low return by itself.

Check out our latest analysis for Reliance Power

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Reliance Power's past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Reliance Power Tell Us?

We're a bit concerned with the trends, because the business is applying 34% less capital than it was five years ago and returns on that capital have stayed flat. This indicates to us that assets are being sold and thus the business is likely shrinking, which you'll remember isn't the typical ingredients for an up-and-coming multi-bagger. In addition to that, since the ROCE doesn't scream "quality" at 6.2%, it's hard to get excited about these developments.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 33% of total assets, this reported ROCE would probably be less than6.2% because total capital employed would be higher.The 6.2% ROCE could be even lower if current liabilities weren't 33% of total assets, because the the formula would show a larger base of total capital employed. So while current liabilities isn't high right now, keep an eye out in case it increases further, because this can introduce some elements of risk.

In Conclusion...

It's a shame to see that Reliance Power is effectively shrinking in terms of its capital base. And in the last five years, the stock has given away 68% so the market doesn't look too hopeful on these trends strengthening any time soon. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

If you'd like to know about the risks facing Reliance Power, we've discovered 1 warning sign that you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.