Capital allocation trends at Sheela Foam (NSE: SFL) are not ideal


If we are to find multi-bagger potential, there are often underlying trends that can provide clues. Ideally, a business will display two trends; first growth return on capital employed (ROCE) and, on the other hand, an increase amount capital employed. Put simply, these types of businesses are dialing machines, which means they continually reinvest their profits at ever higher rates of return. Watch Foam Sheela (NSE: SFL) he has a high ROCE right now, but let’s see how the returns go.

Understanding Return on Capital Employed (ROCE)

Just to clarify if you’re not sure, ROCE is a measure of the pre-tax income (as a percentage) that a business earns on the capital invested in its business. To calculate this metric for Sheela Foam, here is the formula:

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

0.22 = ₹ 3.4 billion ÷ (₹ 21 billion – ₹ 5.4 billion) (Based on the last twelve months up to March 2021).

So, Sheela Foam has a ROCE of 22%. In absolute terms, this is an excellent return and is even better than the consumer durables industry average of 11%.

Check out our latest analysis for Sheela Foam

NSEI: SFL Return on Capital Employed May 31, 2021

Above you can see how Sheela Foam’s current ROCE compares to her past returns on capital, but you can’t say more about the past. If you want, you can check out analyst forecasts covering Sheela Foam here for free.

What does the ROCE trend tell us for Sheela foam?

When we looked at the ROCE trend at Sheela Foam, we didn’t gain much confidence. Historically, returns on capital were even higher at 36%, but they have declined over the past five years. However, as both capital employed and income have increased, it appears that the company is currently continuing to grow, driven by short-term returns. If these investments prove to be successful, it can bode very well for stock performance in the long run.

Similarly, Sheela Foam reduced her current liabilities to 26% of her total assets. This could partly explain why the ROCE has fallen. In addition, it can reduce some aspects of the risk to the business, as the company’s suppliers or short-term creditors now finance less of its operations. Some would argue that this reduces the company’s efficiency in generating ROCE since it now finances more transactions with its own money.

In conclusion…

While returns have plummeted for Sheela Foam lately, we are encouraged to see that sales are increasing and the company is reinvesting in its operations. In addition, the stock has climbed 43% in the past three years, it looks like investors are optimistic about the future. So while investors seem to recognize these promising trends, we would take a closer look at this stock to make sure the other metrics justify the positive view.

Sheela Foam might be attractively priced in other ways, so you might find our free estimate of intrinsic value on our quite valuable platform.

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

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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take into account your goals or your financial situation. We aim to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative information. Simply Wall St has no position in the mentioned stocks.
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