If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating YKT (TYO:2693), we don't think it's current trends fit the mold of a multi-bagger.
What is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for YKT:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.033 = JP¥322m ÷ (JP¥13b - JP¥3.0b) (Based on the trailing twelve months to December 2020).
Thus, YKT has an ROCE of 3.3%. In absolute terms, that's a low return and it also under-performs the Trade Distributors industry average of 6.4%.
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're interested in investigating YKT's past further, check out this free graph of past earnings, revenue and cash flow.
What Can We Tell From YKT's ROCE Trend?
When we looked at the ROCE trend at YKT, we didn't gain much confidence. Around five years ago the returns on capital were 6.1%, but since then they've fallen to 3.3%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
The Bottom Line On YKT's ROCE
To conclude, we've found that YKT is reinvesting in the business, but returns have been falling. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 102% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
On a final note, we found 4 warning signs for YKT (2 don't sit too well with us) you should be aware of.
While YKT 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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