Otani KogyoLtd (TYO:5939) Could Be Struggling To Allocate Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. Having said that, from a first glance at Otani KogyoLtd (TYO:5939) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What is 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 Otani KogyoLtd, this is the formula:

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

0.086 = JP¥317m ÷ (JP¥5.3b - JP¥1.6b) (Based on the trailing twelve months to December 2020).

Therefore, Otani KogyoLtd has an ROCE of 8.6%. 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.

Check out our latest analysis for Otani KogyoLtd

Historical performance is a great place to start when researching a stock so above you can see the gauge for Otani KogyoLtd's ROCE against it's prior returns. If you'd like to look at how Otani KogyoLtd has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Otani KogyoLtd, we didn't gain much confidence. Around five years ago the returns on capital were 12%, but since then they've fallen to 8.6%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

In Conclusion...

In summary, Otani KogyoLtd is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Yet to long term shareholders the stock has gifted them an incredible 117% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

One final note, you should learn about the 3 warning signs we've spotted with Otani KogyoLtd (including 1 which is a bit concerning) .

While Otani KogyoLtd 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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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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