Tokyo Chuo Auction Holdings (HKG:1939) May Have Issues Allocating Its Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Tokyo Chuo Auction Holdings (HKG:1939) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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)

0.04 = HK$14m ÷ (HK$595m - HK$251m) (Based on the trailing twelve months to March 2021).

So, Tokyo Chuo Auction Holdings has an ROCE of 4.0%. Ultimately, that's a low return and it under-performs the Consumer Services industry average of 7.5%.

View 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're interested in investigating Tokyo Chuo Auction Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Tokyo Chuo Auction Holdings doesn't inspire confidence. Over the last five years, returns on capital have decreased to 4.0% from 32% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Tokyo Chuo Auction Holdings has done well to pay down its current liabilities to 42% 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. Keep in mind 42% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line

From the above analysis, we find it rather worrisome that returns on capital and sales for Tokyo Chuo Auction Holdings have fallen, meanwhile the business is employing more capital than it was five years ago. Investors must expect better things on the horizon though because the stock has risen 3.6% in the last year. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

On a final note, we found 2 warning signs for Tokyo Chuo Auction Holdings (1 doesn't sit too well with us) you should be aware of.

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.
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