Some Investors May Be Worried About DENSO's (TSE:6902) 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? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. In light of that, when we looked at DENSO (TSE:6902) and its ROCE trend, we weren't exactly thrilled.

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. The formula for this calculation on DENSO is:

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

0.055 = JP¥381b ÷ (JP¥9.1t - JP¥2.2t) (Based on the trailing twelve months to March 2024).

So, DENSO has an ROCE of 5.5%. In absolute terms, that's a low return but it's around the Auto Components industry average of 6.5%.

Check out our latest analysis for DENSO

In the above chart we have measured DENSO's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering DENSO for free.

What The Trend Of ROCE Can Tell Us

The trend of ROCE doesn't look fantastic because it's fallen from 7.2% five years ago, while the business's capital employed increased by 54%. That being said, DENSO raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. DENSO probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

The Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for DENSO. And long term investors must be optimistic going forward because the stock has returned a huge 151% to shareholders in the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

DENSO could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation for 6902 on our platform quite valuable.

While DENSO 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.