Companies with declining ROCE: Hidden danger to shareholder wealth

Capitalmind has conducted a ten-year longitudinal analysis nearly 800 companies that were operational 10 years ago

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Companies with improving Return on Capital Employed (ROCE) over time tend to deliver better shareholder returns than those with high starting ROCE, according to a study by Capitalmind Financial Services. 

 

ROCE is a financial metric that measures a company's profitability and the efficiency with which it uses its capital. It is calculated by dividing operating profit by the capital employed (the total assets minus current liabilities). A higher ROCE indicates that a company is effectively using its capital to generate profits.

 

The study analyzed nearly 800 companies over a decade and found that many top ROCE companies from a decade ago failed to maintain their performance. The study suggests that steady improvement in ROCE, even from average levels, can be a stronger indicator of long-term success than high initial ROCE figures. 

Most companies see ROCE shift, 16% stayed stable over a decade

   

The data shows that most companies with top ROCE (Return on Capital Employed) a decade ago no longer maintain that high position. Specifically, 7 out of 10 have slipped down, with 1 in 4 top-decile companies now in the bottom half. Interestingly, companies in lower ROCE deciles (1, 2, 3) showed the most improvement. Here are the key takeaways:

 

• 3 out of 10 companies that were top decile 10 years ago were still top decile 1 year ago. This means 7 out of 10 companies from 10 years ago are no longer top decile. Of course, decile 10 companies had nowhere to improve to.

• 1 in 4 top-decile ROCE companies a decade ago are now in the bottom half of their cohort of 800 companies

• The highest proportion of companies showing improvement were in deciles 1, 2 and 3. Put another way, the companies at the bottom of the pile showed the most improvement

• 4 in 10 companies across the whole set worsened on their ROCE decile, while the same number also improved on the same metric

• 45% of companies are within +1 or -1 decile of their starting ROC decile a decade ago. The remaining 55% saw larger moves in their relative Return on Capital employed.

 

Companies with consistently improving ROCE have delivered 25% annual returns as compared to just 8% for those with declining ROCE. In other words, the worst-returning cohort of companies were those that saw consistently declining ROC irrespective of their starting ROC decile 10 years ago. Conversely, the companies that have shown improving ROC have shown significantly better shareholder returns than the overall universe. 

 

Only 59 companies out of 799 have consistently improved ROCE from 10Y ago. According to Capitalmind Financial Services, as of November 2024, the top 20 companies by shareholder returns have recorded to have improved their ROCE to top deciles over the past 10 years. While the universe of 800 companies has delivered a median 10-year cumulative return of 285%, Tips Music Ltd. has delivered a return of 16385% and moved up from ROC decile of 3 (10 years ago) to the

highest decile. Jindal Stainless, which is currently at 4th position in terms of return of 3,600% has witnessed its ROCE trajectory improve significantly from lowest decile of 1 to 9 decile.

 

"Where a company’s Return on Capital is headed matters more than where it starts. Companies that consistently improve their ROC over time—transforming from average to exceptional—tend to deliver superior shareholder returns. On the other hand, even top ROC companies can falter if their competitive advantages erode or if high returns prove temporary. While ROCE is a valuable metric for evaluating efficiency, it must be combined with a forward-looking perspective to identify businesses capable of delivering exceptional long-term returns," said Vijaykumar, Investments & Head of Research, Capitalmind Financial Services.