What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So on that note, SANNO (TYO:3441) looks quite promising in regards to its trends of return on capital.
Understanding 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. The formula for this calculation on SANNO is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.024 = JP¥151m ÷ (JP¥9.7b - JP¥3.3b) (Based on the trailing twelve months to January 2021).
Thus, SANNO has an ROCE of 2.4%. Ultimately, that's a low return and it under-performs the Machinery industry average of 6.4%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for SANNO's ROCE against it's prior returns. If you'd like to look at how SANNO has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
The Trend Of ROCE
Shareholders will be relieved that SANNO has broken into profitability. While the business was unprofitable in the past, it's now turned things around and is earning 2.4% on its capital. While returns have increased, the amount of capital employed by SANNO has remained flat over the period. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.
What We Can Learn From SANNO's ROCE
To bring it all together, SANNO has done well to increase the returns it's generating from its capital employed. Since the stock has returned a staggering 334% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
If you'd like to know more about SANNO, we've spotted 4 warning signs, and 1 of them shouldn't be ignored.
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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