When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. In light of that, from a first glance at RattanIndia Power (NSE:RTNPOWER), we've spotted some signs that it could be struggling, so let's investigate.
Return On Capital Employed (ROCE): What is it?
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 RattanIndia Power is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0072 = ₹755m ÷ (₹189b - ₹84b) (Based on the trailing twelve months to December 2020).
So, RattanIndia Power has an ROCE of 0.7%. In absolute terms, that's a low return and it also under-performs the Renewable Energy industry average of 7.6%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for RattanIndia Power's ROCE against it's prior returns. If you'd like to look at how RattanIndia Power has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
The trend of ROCE at RattanIndia Power is showing some signs of weakness. Unfortunately, returns have declined substantially over the last five years to the 0.7% we see today. What's equally concerning is that the amount of capital deployed in the business has shrunk by 35% over that same period. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. If these underlying trends continue, we wouldn't be too optimistic going forward.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 45%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 0.7%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.
The Key Takeaway
To see RattanIndia Power reducing the capital employed in the business in tandem with diminishing returns, is concerning. Investors haven't taken kindly to these developments, since the stock has declined 70% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
If you'd like to know more about RattanIndia Power, we've spotted 4 warning signs, and 2 of them can't be ignored.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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