Iwabuchi (TYO:5983) Is Finding It Tricky To Allocate Its Capital

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. This indicates the company is producing less profit from its investments and its total assets are decreasing. In light of that, from a first glance at Iwabuchi (TYO:5983), we've spotted some signs that it could be struggling, so let's investigate.

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 Iwabuchi, this is the formula:

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

0.027 = JP¥463m ÷ (JP¥20b - JP¥2.3b) (Based on the trailing twelve months to December 2020).

Thus, Iwabuchi has an ROCE of 2.7%. Ultimately, that's a low return and it under-performs the Electrical industry average of 6.8%.

Check out our latest analysis for Iwabuchi

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Iwabuchi 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

There is reason to be cautious about Iwabuchi, given the returns are trending downwards. About five years ago, returns on capital were 6.0%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Iwabuchi becoming one if things continue as they have.

What We Can Learn From Iwabuchi's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Yet despite these concerning fundamentals, the stock has performed strongly with a 45% return 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.

One more thing: We've identified 4 warning signs with Iwabuchi (at least 1 which is concerning) , and understanding these would certainly be useful.

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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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