Returns On Capital Tell Us A Lot About SantoLtd (TYO:1788)

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. So after we looked into SantoLtd (TYO:1788), the trends above didn't look too great.

What is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on SantoLtd is:

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

0.03 = JP¥77m ÷ (JP¥3.9b - JP¥1.4b) (Based on the trailing twelve months to September 2020).

Therefore, SantoLtd has an ROCE of 3.0%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 10%.

Check out our latest analysis for SantoLtd

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

So How Is SantoLtd's ROCE Trending?

In terms of SantoLtd's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 5.8% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect SantoLtd to turn into a multi-bagger.

What We Can Learn From SantoLtd's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. However the stock has delivered a 75% return to shareholders over the last five years, so investors might be expecting the trends to turn around. 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 3 warning signs we've spotted with SantoLtd (including 1 which is is potentially serious) .

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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