There Are Reasons To Feel Uneasy About Setco Automotive's (NSE:SETCO) Returns On Capital

Simply Wall St · 10/18 00:40

There are a few key trends to look for if we want to identify the next multi-bagger. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Setco Automotive (NSE:SETCO), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

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. The formula for this calculation on Setco Automotive is:

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

0.12 = ₹441m ÷ (₹5.6b - ₹1.8b) (Based on the trailing twelve months to June 2024).

So, Setco Automotive has an ROCE of 12%. In absolute terms, that's a pretty standard return but compared to the Auto Components industry average it falls behind.

Check out our latest analysis for Setco Automotive

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NSEI:SETCO Return on Capital Employed October 18th 2024

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Setco Automotive has performed in the past in other metrics, you can view this free graph of Setco Automotive's past earnings, revenue and cash flow.

The Trend Of ROCE

In terms of Setco Automotive'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, 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, Setco Automotive has done well to pay down its current liabilities to 33% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

In Conclusion...

While returns have fallen for Setco Automotive in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. However, despite the promising trends, the stock has fallen 26% over the last five years, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One final note, you should learn about the 3 warning signs we've spotted with Setco Automotive (including 2 which are significant) .

While Setco Automotive 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.