Orient Refractories (NSE: ORIENTREF) may have difficulty using its capital efficiently

Finding a business that has the potential to grow significantly isn’t easy, but it is possible if we take a look at a few key financial metrics. Ideally, a business will display two trends; first growth return on capital employed (ROCE) and on the other hand, an increase amount capital employed. This shows us that it is a composing machine, capable of continually reinvesting its profits in the business and generating higher returns. Watch Oriental refractories (NSE: ORIENTREF) it has a high ROCE right now, but let’s see how the returns move.

Understanding Return on Capital Employed (ROCE)

For those who don’t know what ROCE is, it measures the amount of pre-tax profit a business can generate from the capital employed in its business. The formula for this calculation on Orient Refractories is:

Return on capital employed = Profit before interest and taxes (EBIT) ÷ (Total assets – Current liabilities)

0.22 = ₹ 934m ÷ (₹ 5.8b – ₹ 1.5b) (Based on the last twelve months up to December 2020).

So, Orient Refractories has a ROCE of 22%. In absolute terms, this is a great return and it’s even better than the basic materials industry average of 13%.

Check out our latest review for Orient Refractories

Above you can see how Orient Refractories’ current ROCE compares to its previous returns on capital, but there is little you can say about the past. If you are interested, you can view analyst forecasts in our free analyst forecast report for the company.

The ROCE trend

On the surface, the trend for ROCE at Orient Refractories does not inspire confidence. While it’s comforting that ROCE is high, it was 37% five years ago. However, it looks like Orient Refractories may be reinvesting for long-term growth, as while capital employed has increased, the company’s sales haven’t changed much in the past 12 months. It may take some time for the business to begin to see a change in the benefits of these investments.

Our opinion on the ROCE of Orient Refractories

To conclude, we found that Orient Refractories is reinvesting in the business, but the returns are declining. Investors must think there are better things to come because the stock took it out of the park, offering a 281% gain to shareholders who have owned in the past five years. But if the trajectory of those underlying trends continues, we think the likelihood of it being multi-bagging from here is not high.

Like most businesses, Orient Refractories carries certain risks, and we have found 2 warning signs that you need to be aware of.

High yields are a key ingredient to strong performance, so check out our free list of stocks generating high returns on equity with strong balance sheets.

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