If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Although, when we looked at Shinpo (TYO:5903), it didn't seem to tick all of these boxes.
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. Analysts use this formula to calculate it for Shinpo:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.089 = JP¥483m ÷ (JP¥6.4b - JP¥915m) (Based on the trailing twelve months to December 2020).
So, Shinpo has an ROCE of 8.9%. On its own that's a low return, but compared to the average of 6.4% generated by the Machinery industry, it's much better.
Above you can see how the current ROCE for Shinpo compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is Shinpo's ROCE Trending?
When we looked at the ROCE trend at Shinpo, we didn't gain much confidence. Around five years ago the returns on capital were 20%, but since then they've fallen to 8.9%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
The Bottom Line
In summary, we're somewhat concerned by Shinpo's diminishing returns on increasing amounts of capital. Yet despite these poor fundamentals, the stock has gained a huge 149% over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
If you'd like to know more about Shinpo, we've spotted 4 warning signs, and 1 of them can't be ignored.
While Shinpo isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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