Capital Allocation Trends At VA Tech Wabag (NSE:WABAG) Aren't Ideal

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at VA Tech Wabag (NSE:WABAG), it didn't seem to tick all of these boxes.

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 VA Tech Wabag, this is the formula:

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

0.12 = ₹2.2b ÷ (₹40b - ₹22b) (Based on the trailing twelve months to June 2022).

So, VA Tech Wabag has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Water Utilities industry average of 7.1% it's much better.

See our latest analysis for VA Tech Wabag

Above you can see how the current ROCE for VA Tech Wabag compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering VA Tech Wabag here for free.

What The Trend Of ROCE Can Tell Us

In terms of VA Tech Wabag's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 23%, but since then they've fallen to 12%. However it looks like VA Tech Wabag might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, VA Tech Wabag's current liabilities are still rather high at 54% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line On VA Tech Wabag's ROCE

Bringing it all together, while we're somewhat encouraged by VA Tech Wabag's reinvestment in its own business, we're aware that returns are shrinking. And investors appear hesitant that the trends will pick up because the stock has fallen 54% in the last five years. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

VA Tech Wabag could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.