Here's What's Concerning About Tokyo Chuo Auction Holdings' (HKG:1939) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Tokyo Chuo Auction Holdings (HKG:1939) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Tokyo Chuo Auction Holdings, this is the formula:

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

0.037 = HK$12m ÷ (HK$581m - HK$252m) (Based on the trailing twelve months to March 2022).

So, Tokyo Chuo Auction Holdings has an ROCE of 3.7%. In absolute terms, that's a low return and it also under-performs the Consumer Services industry average of 9.3%.

Our analysis indicates that 1939 is potentially overvalued!

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Tokyo Chuo Auction Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

In terms of Tokyo Chuo Auction Holdings' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 33%, but since then they've fallen to 3.7%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Tokyo Chuo Auction Holdings has decreased its current liabilities to 43% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Bottom Line

To conclude, we've found that Tokyo Chuo Auction Holdings is reinvesting in the business, but returns have been falling. Unsurprisingly, the stock has only gained 8.1% 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.

Tokyo Chuo Auction Holdings does have some risks, we noticed 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.