There Are Reasons To Feel Uneasy About Tokyo Chuo Auction Holdings' (HKG:1939) Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Tokyo Chuo Auction Holdings (HKG:1939), we don't think it's current trends fit the mold of a multi-bagger.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from 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)

0.099 = HK$35m ÷ (HK$652m - HK$303m) (Based on the trailing twelve months to September 2021).

Thus, Tokyo Chuo Auction Holdings has an ROCE of 9.9%. On its own that's a low return, but compared to the average of 8.2% generated by the Consumer Services industry, it's much better.

Check out our latest analysis for Tokyo Chuo Auction Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Tokyo Chuo Auction Holdings' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Tokyo Chuo Auction Holdings, check out these free graphs here.

How Are Returns Trending?

When we looked at the ROCE trend at Tokyo Chuo Auction Holdings, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 9.9% from 33% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Tokyo Chuo Auction Holdings has done well to pay down its current liabilities to 46% 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Tokyo Chuo Auction Holdings is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 21% in the last three years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Tokyo Chuo Auction Holdings does have some risks, we noticed 3 warning signs (and 1 which can't be ignored) we think you should know about.

While Tokyo Chuo Auction Holdings isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.