Be Wary Of Precision Tsugami (China) (HKG:1651) And Its Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. Although, when we looked at Precision Tsugami (China) (HKG:1651), it didn't seem to tick all of these boxes.

What is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Precision Tsugami (China), this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.18 = CN¥284m ÷ (CN¥2.2b - CN¥581m) (Based on the trailing twelve months to September 2020).

Thus, Precision Tsugami (China) has an ROCE of 18%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 9.0% it's much better.

Check out our latest analysis for Precision Tsugami (China)

Above you can see how the current ROCE for Precision Tsugami (China) compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

When we looked at the ROCE trend at Precision Tsugami (China), we didn't gain much confidence. Over the last five years, returns on capital have decreased to 18% from 33% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Precision Tsugami (China) has decreased its current liabilities to 27% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Precision Tsugami (China)'s reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 17% over the last three years, which potentially indicates that investors are accounting for this going forward. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

On a separate note, we've found 1 warning sign for Precision Tsugami (China) you'll probably want to know about.

While Precision Tsugami (China) may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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