There Are Reasons To Feel Uneasy About Tokuden's (TYO:3437) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Tokuden (TYO:3437), we don't think it's current trends fit the mold of a multi-bagger.

Understanding 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 Tokuden:

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

0.074 = JP¥479m ÷ (JP¥8.6b - JP¥2.2b) (Based on the trailing twelve months to December 2020).

So, Tokuden has an ROCE of 7.4%. On its own, that's a low figure but it's around the 6.4% average generated by the Machinery industry.

Check out our latest analysis for Tokuden

Historical performance is a great place to start when researching a stock so above you can see the gauge for Tokuden's ROCE against it's prior returns. If you're interested in investigating Tokuden's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

On the surface, the trend of ROCE at Tokuden doesn't inspire confidence. Over the last five years, returns on capital have decreased to 7.4% from 12% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Tokuden has decreased its current liabilities to 25% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Key Takeaway

In summary, we're somewhat concerned by Tokuden's diminishing returns on increasing amounts of capital. Yet despite these poor fundamentals, the stock has gained a huge 104% over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Tokuden does have some risks though, and we've spotted 1 warning sign for Tokuden that you might be interested in.

While Tokuden 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. 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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