Returns On Capital - An Important Metric For Nihon Kogyo (TYO:5279)

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, we've noticed some promising trends at Nihon Kogyo (TYO:5279) so let's look a bit deeper.

Understanding 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. Analysts use this formula to calculate it for Nihon Kogyo:

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

0.06 = JP¥476m ÷ (JP¥13b - JP¥5.5b) (Based on the trailing twelve months to December 2020).

Thus, Nihon Kogyo has an ROCE of 6.0%. Ultimately, that's a low return and it under-performs the Construction industry average of 9.9%.

See 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 want to delve into the historical earnings, revenue and cash flow of Nihon Kogyo, check out these free graphs here.

How Are Returns Trending?

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 40% over the last five years. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. 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.

On a side note, Nihon Kogyo's current liabilities are still rather high at 41% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

Our Take On Nihon Kogyo's ROCE

To bring it all together, Nihon Kogyo has done well to increase the returns it's generating from its capital employed. Considering the stock has delivered 13% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.

If you'd like to know about the risks facing Nihon Kogyo, we've discovered 3 warning signs that you should be aware of.

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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