The Returns On Capital At Kumagai GumiLtd (TSE:1861) Don't Inspire Confidence

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. In light of that, when we looked at Kumagai GumiLtd (TSE:1861) and its ROCE trend, we weren't exactly thrilled.

We've discovered 2 warning signs about Kumagai GumiLtd. View them for free.

Understanding 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. Analysts use this formula to calculate it for Kumagai GumiLtd:

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

0.022 = JP¥4.9b ÷ (JP¥441b - JP¥214b) (Based on the trailing twelve months to December 2024).

Thus, Kumagai GumiLtd has an ROCE of 2.2%. Ultimately, that's a low return and it under-performs the Construction industry average of 9.2%.

View our latest analysis for Kumagai GumiLtd

Above you can see how the current ROCE for Kumagai GumiLtd compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Kumagai GumiLtd for free.

The Trend Of ROCE

In terms of Kumagai GumiLtd's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 2.2% from 16% five years ago. 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

Another thing to note, Kumagai GumiLtd has a high ratio of current liabilities to total assets of 48%. 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 Bottom Line On Kumagai GumiLtd's ROCE

Bringing it all together, while we're somewhat encouraged by Kumagai GumiLtd's reinvestment in its own business, we're aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 104% return in the last five years, so the market appears to be rosy about its future. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One more thing to note, we've identified 2 warning signs with Kumagai GumiLtd and understanding them should be part of your investment process.

While Kumagai GumiLtd 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.