Capital Allocation Trends At Asahi Songwon Colors (NSE:ASAHISONG) Aren't Ideal

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Asahi Songwon Colors (NSE:ASAHISONG) 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)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Asahi Songwon Colors:

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

0.0057 = ₹20m ÷ (₹5.7b - ₹2.2b) (Based on the trailing twelve months to March 2024).

Therefore, Asahi Songwon Colors has an ROCE of 0.6%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 13%.

View 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 want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Asahi Songwon Colors.

What Does the ROCE Trend For Asahi Songwon Colors Tell Us?

In terms of Asahi Songwon Colors' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 14% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 38%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

In Conclusion...

In summary, we're somewhat concerned by Asahi Songwon Colors' diminishing returns on increasing amounts of capital. Since the stock has skyrocketed 290% over the last five years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One final note, you should learn about the 4 warning signs we've spotted with Asahi Songwon Colors (including 2 which are a bit concerning) .

While Asahi Songwon Colors 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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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com