Is There More Growth In Store For Nihon Kogyo's (TYO:5279) Returns On Capital?

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at Nihon Kogyo (TYO:5279) and its trend of ROCE, we really liked what we saw.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Nihon Kogyo, this is the formula:

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

0.059 = JP¥431m ÷ (JP¥13b - JP¥5.3b) (Based on the trailing twelve months to September 2020).

So, Nihon Kogyo has an ROCE of 5.9%. 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 Nihon Kogyo

Historical performance is a great place to start when researching a stock so above you can see the gauge for Nihon Kogyo's ROCE against it's prior returns. If you'd like to look at how Nihon Kogyo 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

Nihon Kogyo's ROCE growth is quite impressive. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 44% over the last five years. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.

Another thing to note, Nihon Kogyo has a high ratio of current liabilities to total assets of 42%. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

In Conclusion...

As discussed above, Nihon Kogyo appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Since the total return from the stock has been almost flat over the last five years, there might be an opportunity here if the valuation looks good. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

If you want to continue researching Nihon Kogyo, you might be interested to know about the 3 warning signs that our analysis has discovered.

While Nihon Kogyo 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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