Should You Be Impressed By Kyokuto SankiLtd's (TYO:6233) Returns on Capital?

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. Having said that, from a first glance at Kyokuto SankiLtd (TYO:6233) 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 Kyokuto SankiLtd, this is the formula:

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

0.036 = JP¥153m ÷ (JP¥8.7b - JP¥4.4b) (Based on the trailing twelve months to December 2020).

Thus, Kyokuto SankiLtd has an ROCE of 3.6%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 6.4%.

See our latest analysis for Kyokuto SankiLtd

Historical performance is a great place to start when researching a stock so above you can see the gauge for Kyokuto SankiLtd's ROCE against it's prior returns. If you're interested in investigating Kyokuto SankiLtd's past further, check out 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 Kyokuto SankiLtd, we didn't gain much confidence. Around four years ago the returns on capital were 11%, but since then they've fallen to 3.6%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a separate but related note, it's important to know that Kyokuto SankiLtd has a current liabilities to total assets ratio of 51%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Kyokuto SankiLtd's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 18% over the last year, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 5 warning signs for Kyokuto SankiLtd (of which 2 can't be ignored!) that you should know about.

While Kyokuto SankiLtd 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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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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