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

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Tata Power (NSE:TATAPOWER), we don't think it's current trends fit the mold of a multi-bagger.

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. To calculate this metric for Tata Power, this is the formula:

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

0.05 = ₹38b ÷ (₹1.2t - ₹451b) (Based on the trailing twelve months to September 2022).

Therefore, Tata Power has an ROCE of 5.0%. In absolute terms, that's a low return and it also under-performs the Electric Utilities industry average of 7.3%.

See 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.

So How Is Tata Power's ROCE Trending?

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 5.0%. 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. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Tata Power has done well to pay down its current liabilities to 37% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

In Conclusion...

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Tata Power. And the stock has done incredibly well with a 148% return over the last five years, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we'd be optimistic on the stock going forward.

On a final note, we found 2 warning signs for Tata Power (1 makes us a bit uncomfortable) you should be aware of.

While Tata Power isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.