Returns On Capital At Tata Power (NSE:TATAPOWER) Paint A Concerning Picture

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. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. In light of that, when we looked at Tata Power (NSE:TATAPOWER) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Tata Power:

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

0.063 = ₹43b ÷ (₹1.0t - ₹367b) (Based on the trailing twelve months to December 2021).

Therefore, Tata Power has an ROCE of 6.3%. On its own, that's a low figure but it's around the 7.9% average generated by the Electric Utilities industry.

Check out our latest analysis for Tata Power

In the above chart we have measured Tata Power's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For Tata Power Tell Us?

When we looked at the ROCE trend at Tata Power, we didn't gain much confidence. Around five years ago the returns on capital were 10%, but since then they've fallen to 6.3%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

The Bottom Line On Tata Power's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Tata Power is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 232% to shareholders in the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

On a final note, we found 2 warning signs for Tata Power (1 is concerning) you should be aware of.

While Tata Power 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.