We're Watching These Trends At Sanso ElectricLtd (TYO:6518)

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at Sanso ElectricLtd (TYO:6518) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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 Sanso ElectricLtd, this is the formula:

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

0.023 = JP¥260m ÷ (JP¥15b - JP¥3.9b) (Based on the trailing twelve months to September 2020).

So, Sanso ElectricLtd has an ROCE of 2.3%. Ultimately, that's a low return and it under-performs the Machinery industry average of 6.7%.

Check out our latest analysis for Sanso ElectricLtd

Historical performance is a great place to start when researching a stock so above you can see the gauge for Sanso ElectricLtd's ROCE against it's prior returns. If you're interested in investigating Sanso ElectricLtd'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 Sanso ElectricLtd, we didn't gain much confidence. Around five years ago the returns on capital were 5.5%, but since then they've fallen to 2.3%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

In Conclusion...

We're a bit apprehensive about Sanso ElectricLtd because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Yet despite these concerning fundamentals, the stock has performed strongly with a 89% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

On a final note, we found 3 warning signs for Sanso ElectricLtd (1 can't be ignored) you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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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