Asahi Songwon Colors (NSE:ASAHISONG) May Have Issues Allocating Its 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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Asahi Songwon Colors (NSE:ASAHISONG), we don't think it's current trends fit the mold of a multi-bagger.

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. The formula for this calculation on Asahi Songwon Colors is:

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

0.14 = ₹411m ÷ (₹3.9b - ₹908m) (Based on the trailing twelve months to March 2021).

Therefore, Asahi Songwon Colors has an ROCE of 14%. That's a relatively normal return on capital, and it's around the 16% generated by the Chemicals industry.

Check out our latest analysis for Asahi Songwon Colors

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 Asahi Songwon Colors has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Asahi Songwon Colors' ROCE Trending?

On the surface, the trend of ROCE at Asahi Songwon Colors doesn't inspire confidence. Over the last five years, returns on capital have decreased to 14% from 20% five years ago. However it looks like Asahi Songwon Colors might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. 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.

The Bottom Line

In summary, Asahi Songwon Colors is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 136% gain to shareholders who have held over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Asahi Songwon Colors does have some risks, we noticed 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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This article by Simply Wall St is general in nature. 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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