Showa ManufacturingLtd (FKSE:5953) Has Some Difficulty Using Its Capital Effectively

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. And from a first read, things don't look too good at Showa ManufacturingLtd (FKSE:5953), so let's see why.

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. Analysts use this formula to calculate it for Showa ManufacturingLtd:

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

0.0098 = JP¥76m ÷ (JP¥15b - JP¥7.1b) (Based on the trailing twelve months to December 2020).

Thus, Showa ManufacturingLtd has an ROCE of 1.0%. Ultimately, that's a low return and it under-performs the Building industry average of 7.8%.

View our latest analysis for Showa ManufacturingLtd

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, revenue and cash flow of Showa ManufacturingLtd, check out these free graphs here.

What Does the ROCE Trend For Showa ManufacturingLtd Tell Us?

In terms of Showa ManufacturingLtd's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 4.4%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Showa ManufacturingLtd to turn into a multi-bagger.

On a separate but related note, it's important to know that Showa ManufacturingLtd has a current liabilities to total assets ratio of 48%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. In spite of that, the stock has delivered a 13% return to shareholders who held over the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

Showa ManufacturingLtd does have some risks, we noticed 4 warning signs (and 2 which can't be ignored) we think you should know about.

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. 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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