Be Wary Of SantoLtd (TSE:1788) And Its Returns On Capital

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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 reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. Having said that, after a brief look, SantoLtd (TSE:1788) we aren't filled with optimism, but let's investigate further.

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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 SantoLtd is:

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

0.041 = JP¥138m ÷ (JP¥5.1b - JP¥1.7b) (Based on the trailing twelve months to December 2024).

So, SantoLtd has an ROCE of 4.1%. Ultimately, that's a low return and it under-performs the Construction industry average of 8.9%.

View our latest analysis for SantoLtd

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 SantoLtd has performed in the past in other metrics, you can view this free graph of SantoLtd's past earnings, revenue and cash flow .

What Does the ROCE Trend For SantoLtd Tell Us?

There is reason to be cautious about SantoLtd, given the returns are trending downwards. To be more specific, the ROCE was 6.9% one year ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect SantoLtd to turn into a multi-bagger.

The Bottom Line

In summary, it's unfortunate that SantoLtd is generating lower returns from the same amount of capital. However the stock has delivered a 97% return to shareholders over the last five years, so investors might be expecting the trends to turn around. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

If you'd like to know more about SantoLtd, we've spotted 4 warning signs, and 1 of them can't be ignored.

While SantoLtd 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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.