Here’s why high ROCEs do not guarantee high returns

Do high return ratios drive a stock forward?

Investors of Astral Pipes would say it does.

Astral Pipes’ consistently high ROCE

Between FY19-23, the pipe and fitting manufacturer maintained an impressive five-year average return on capital employed of 26%.

How did the market react?

The market rewarded it with an annual share price growth of 34% in the same period.

Castrol’s lacklustre returns

In contrast, Castrol maintained an ROCE of 76% between FY19-23 (contd.)

Castrol’s lacklustre returns

But the stock gave only a 6% annual return in that period. To know why, we must recap how ROCE is calculated.

How is ROCE calculated?

It is the ratio between a company’s earnings before interest and taxes in a given period (numerator) to the capital employed i.e. shareholder’s equity plus total debt (denominator)

How does a company earn high ROCEs?

Either it improves its earnings or decreases shareholder equity.

What drove each company’s return ratios?

Astral was able to post high ROCEs by growing its earnings by finding new growth avenues. Whereas Castrol took the route of paying high dividends.

What does the market prefer?

So, it is clear that the market more often than not rewards businesses that reinvest to generate high ROCEs rather than paying hefty dividends.

Companies with high ROCE and low dividend payout

10 companies by market cap from the BSE 500 universe sharing the following traits: Five-year average ROCE of at least 15%, Five-year average dividend payout ratio of less than 30%

To get investment insights delivered straight to your inbox

See More