What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. So when we looked at Tohoku Chemical (TYO:7446) and its trend of ROCE, we really liked what we saw.
What is 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. To calculate this metric for Tohoku Chemical, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.071 = JP¥472m ÷ (JP¥17b - JP¥9.9b) (Based on the trailing twelve months to December 2020).
Therefore, Tohoku Chemical has an ROCE of 7.1%. On its own, that's a low figure but it's around the 6.4% average generated by the Trade Distributors industry.
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 Tohoku Chemical 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
Tohoku Chemical has not disappointed with their ROCE growth. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 103% over the last five years. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.
Another thing to note, Tohoku Chemical has a high ratio of current liabilities to total assets of 60%. 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.
To bring it all together, Tohoku Chemical has done well to increase the returns it's generating from its capital employed. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 55% return over the last five years. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
On a final note, we've found 3 warning signs for Tohoku Chemical that we think you should be aware of.
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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