Does SantoLtd's (TYO:1788) Returns On Capital Reflect Well On The Business?

When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. On that note, looking into SantoLtd (TYO:1788), we weren't too upbeat about how things were going.

Return On Capital Employed (ROCE): What is it?

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. To calculate this metric for SantoLtd, this is the formula:

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

0.029 = JP¥76m ÷ (JP¥4.6b - JP¥2.0b) (Based on the trailing twelve months to December 2020).

Thus, SantoLtd has an ROCE of 2.9%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 9.9%.

See our latest analysis for SantoLtd

Historical performance is a great place to start when researching a stock so above you can see the gauge for SantoLtd's ROCE against it's prior returns. If you'd like to look at how SantoLtd has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From SantoLtd's ROCE Trend?

There is reason to be cautious about SantoLtd, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 4.6% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. 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 SantoLtd to turn into a multi-bagger.

On a side note, SantoLtd's current liabilities are still rather high at 44% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On SantoLtd's ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 89% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

SantoLtd does have some risks though, and we've spotted 2 warning signs for SantoLtd that you might be interested in.

While SantoLtd isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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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