If you're looking for a multi-bagger, there's a few things to keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Shinpo (TYO:5903) and its ROCE trend, we weren't exactly thrilled.
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 Shinpo is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = JP¥560m ÷ (JP¥5.9b - JP¥672m) (Based on the trailing twelve months to September 2020).
Thus, Shinpo has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 6.8% it's much better.
Check out our latest analysis for Shinpo
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'd like to see what analysts are forecasting going forward, you should check out our free report for Shinpo.
The Trend Of ROCE
When we looked at the ROCE trend at Shinpo, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 11% from 19% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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
From the above analysis, we find it rather worrisome that returns on capital and sales for Shinpo have fallen, meanwhile the business is employing more capital than it was five years ago. Since the stock has skyrocketed 147% over the last five years, it looks like investors have high expectations of the stock. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
One more thing to note, we've identified 2 warning signs with Shinpo and understanding these should be part of your investment process.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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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About TSE:5903
Shinpo
Manufactures and sells smokeless roasters in Japan and internationally.
Flawless balance sheet average dividend payer.
