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One simple indicator that has mostly hit bull's eye in spotting multibaggers

Better capital efficiency in turn leads to shareholder wealth creation.

Updated: Aug 16, 2018, 11.19 AM IST
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Want to crack the multibagger code? Return on capital employed (RoCE) can be a useful guide.

In short, it's a measure of capital efficiency for that dream investment portfolio. And in the listed BSE universe, the options are plenty where the return on capital has been on the rise for the past five years.

The list features companies like Gabriel India and Rane Brake Lining from the auto ancillary sector and Grauer & Weil (India) and IG Petrochemicals from chemicals space. Investment & Precison Casting from casting or forging and Oracle Financial Services Software in the IT sector are others that make it to the list.

A majority of these firms have already delivered multibagger returns over the past years.

RoCE is the measure of earnings before interest and taxes (EBIT) for every rupee of capital (equity and debt) employed in the company. So, the ratio effectively measures the capital efficiency of the company.

But look before you leap. One should also closely monitor growth prospects of the industry and the investment in productive capacities before taking any positions in such companies.

Better capital efficiency in turn leads to shareholder wealth creation.

In terms of stock performance, Grauer & Weil and IG Petrochemicals rallied 1,200 per cent and 2,800 per cent, respectively, during the past five years till August 8. Gabriel India, Investment & Precision Castings and Oracle Financial Services Software gained 720 per cent, 995 per cent and 32 per cent, respectively, during the same period.

Data available with Ace Equity till August 9 were considered for the article.

Brokerage firm Anand Rathi Financial Services has ‘Buy’ rating on Gabriel India with a target price of Rs 192. “The focus on exports and replacements would provide the growth fillip for the next two years. Thus, we expect revenue to grow 14.5 per cent over FY18-20 and, with stable margins, we expect earnings to grow 19 per cent, leading to an EPS of Rs 9.6,” Anand Rathi said in a report.

Well-known smallcap investor Anil Kumar Goel was holding 1.87 per cent in company as of June 30. Mumbai-based broking firm Nalanda Securities also has ‘Buy’ on IG Petrochemicals with a target price of Rs 649.

The brokerage house added that the company has proposed a new brownfield expansion plan to increase its capacity by around 59,000 mtpa to 2,28,250 mtpa, from the current 1,69,110 mtpa. This expansion creates strong visibility of IGPL in the Pthalic Anhydride (PAN) space and the company will control more than 50 per cent market share in the Pthalic Anhydride space.

Market experts have their own take on the rising RoCE. Independent analyst Ambareesh Baliga said, “Increasing RoCE in tandem with rising top line make a good story from investment perspective.”

Oracle Financial Services and Grauer & Weil are the two companies whose net sales increased with RoCE during the past five years.

Kolkata-based investor Arun Mukherjee chipped in: “Measuring a stock on the basis of RoCE depends on case to case basis. Sometimes, there is an inflated RoCE.”

On Grauer & Weil, Aveek Mitra, Aveksat Financial Advisory said, “Except the Kandivali rental income increase, I have not much hope from other businesses as of now. We missed to sell fully at higher levels. So, a few are still left. We would keep holding.”

On the other hand, there are 60 companies on the exchange whose RoCE increased during the past three years. Only four from the list gave negative return during the past three years.

Tasty Bite Eatables, VIP Industries, Thirumalai Chemicals, Prakash Industries, PPAP Automotive, Sterlite Technologies, Precision Wires, Panama Petrochem, DCM Shriram, Asian Hotels, Blue Star, Ashok Leyland, Hester Biosciences, Jyothy Labs and Tata Chemicals are some of the players whose RoCE expanded on a YoY basis since the end of 2014-15.

Ekansh Mittal, founder, Katalyst Wealth, said, “Rising RoCE in general is good, but one has to dig deep to know whether the business is cyclical or not, because the ratio could be rising for a cyclical company. But a lot of time, you would end up buying at the peak or before the cycle is about to turn bad.”

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