What Naito's (TYO:7624) Returns On Capital Can Tell Us

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. So after glancing at the trends within Naito (TYO:7624), we weren't too hopeful.

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. The formula for this calculation on Naito is:

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

0.024 = JP¥282m ÷ (JP¥15b - JP¥3.1b) (Based on the trailing twelve months to August 2020).

Thus, Naito has an ROCE of 2.4%. In absolute terms, that's a low return and it also under-performs the Trade Distributors industry average of 6.3%.

View our latest analysis for Naito

Historical performance is a great place to start when researching a stock so above you can see the gauge for Naito's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Naito, check out these free graphs here.

The Trend Of ROCE

In terms of Naito's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 5.2% that they were earning five years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Naito becoming one if things continue as they have.

On a side note, Naito has done well to pay down its current liabilities to 21% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

In Conclusion...

In summary, it's unfortunate that Naito is generating lower returns from the same amount of capital. In spite of that, the stock has delivered a 2.1% return to shareholders who held over the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

On a separate note, we've found 2 warning signs for Naito you'll probably want to know about.

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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