Slowing Rates Of Return At Tata Power (NSE:TATAPOWER) Leave Little Room For Excitement

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Tata Power (NSE:TATAPOWER), we don't think it's current trends fit the mold of a multi-bagger.

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. Analysts use this formula to calculate it for Tata Power:

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

0.069 = ₹58b ÷ (₹1.3t - ₹441b) (Based on the trailing twelve months to June 2023).

So, Tata Power has an ROCE of 6.9%. On its own that's a low return on capital but it's in line with the industry's average returns of 6.9%.

View 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 The Trend Of ROCE Can Tell Us

In terms of Tata Power's historical ROCE trend, it doesn't exactly demand attention. The company has employed 89% more capital in the last five years, and the returns on that capital have remained stable at 6.9%. 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.

One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 34% of total assets, is good to see from a business owner's perspective. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.

The Bottom Line

As we've seen above, Tata Power's returns on capital haven't increased but it is reinvesting in the business. Yet to long term shareholders the stock has gifted them an incredible 249% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

One more thing: We've identified 3 warning signs with Tata Power (at least 2 which can't be ignored) , and understanding these would certainly be useful.

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.