The Returns On Capital At Tata Power (NSE:TATAPOWER) Don't Inspire Confidence

To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Tata Power (NSE:TATAPOWER) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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

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)

0.07 = ₹47b ÷ (₹989b - ₹309b) (Based on the trailing twelve months to June 2021).

So, Tata Power has an ROCE of 7.0%. In absolute terms, that's a low return but it's around the Electric Utilities industry average of 8.5%.

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'd like, you can check out the forecasts from the analysts covering Tata Power here for free.

So How Is Tata Power's ROCE Trending?

When we looked at the ROCE trend at Tata Power, we didn't gain much confidence. To be more specific, ROCE has fallen from 14% over the last five years. 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 Key Takeaway

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 the stock has done incredibly well with a 200% 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 3 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.

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.

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