Japan Steel Works (TSE:5631) Could Be At Risk Of Shrinking As A Company

When researching a stock for investment, what can tell us that the company is in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. In light of that, from a first glance at Japan Steel Works (TSE:5631), we've spotted some signs that it could be struggling, so let's investigate.

Return On Capital Employed (ROCE): What Is It?

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 Japan Steel Works, this is the formula:

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

0.094 = JP¥21b ÷ (JP¥365b - JP¥146b) (Based on the trailing twelve months to September 2024).

Thus, Japan Steel Works has an ROCE of 9.4%. On its own, that's a low figure but it's around the 8.0% average generated by the Machinery industry.

Check out our latest analysis for Japan Steel Works

In the above chart we have measured Japan Steel Works' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Japan Steel Works .

What Does the ROCE Trend For Japan Steel Works Tell Us?

We are a bit worried about the trend of returns on capital at Japan Steel Works. Unfortunately the returns on capital have diminished from the 12% 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. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Japan Steel Works becoming one if things continue as they have.

On a separate but related note, it's important to know that Japan Steel Works has a current liabilities to total assets ratio of 40%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On Japan Steel Works' ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Yet despite these poor fundamentals, the stock has gained a huge 202% over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Japan Steel Works does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is a bit unpleasant...

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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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.