To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we’d want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after investigating Sundaram-Clayton (NSE:SUNCLAYLTD), we don’t think it’s current trends fit the mold of a multi-bagger.
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. The formula for this calculation on Sundaram-Clayton is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.12 = ₹13b ÷ (₹219b – ₹112b) (Based on the trailing twelve months to September 2020).
So, Sundaram-Clayton has an ROCE of 12%. On its own, that’s a standard return, however it’s much better than the 7.1% generated by the Auto Components industry.
See our latest analysis for Sundaram-Clayton
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 want to delve into the historical earnings, revenue and cash flow of Sundaram-Clayton, check out these free graphs here.
How Are Returns Trending?
When we looked at the ROCE trend at Sundaram-Clayton, we didn’t gain much confidence. Around five years ago the returns on capital were 20%, but since then they’ve fallen to 12%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it’s actually producing a lower return – “less bang for their buck” per se.
On a separate but related note, it’s important to know that Sundaram-Clayton has a current liabilities to total assets ratio of 51%, which we’d consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we’d like to see this reduce as that would mean fewer obligations bearing risks.
What We Can Learn From Sundaram-Clayton’s ROCE
We’re a bit apprehensive about Sundaram-Clayton because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Yet despite these concerning fundamentals, the stock has performed strongly with a 59% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don’t bode well for long term performance so unless they reverse, we’d start looking elsewhere.
If you want to know some of the risks facing Sundaram-Clayton we’ve found 5 warning signs (2 can’t be ignored!) that you should be aware of before investing here.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
If you decide to trade Sundaram-Clayton, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account.
This article by Simply Wall St is general in nature. 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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.