Japan Steel Works (TSE:5631) Could Be Struggling To Allocate Capital

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? 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 combination can tell you that not only is the company investing less, it's earning less on what it does invest. So after glancing at the trends within Japan Steel Works (TSE:5631), we weren't too hopeful.

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

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Japan Steel Works:

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

0.081 = JP¥18b ÷ (JP¥367b - JP¥144b) (Based on the trailing twelve months to March 2024).

Thus, Japan Steel Works has an ROCE of 8.1%. On its own that's a low return on capital but it's in line with the industry's average returns of 8.0%.

See 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, you can check out the forecasts from the analysts covering Japan Steel Works for free.

So How Is Japan Steel Works' ROCE Trending?

There is reason to be cautious about Japan Steel Works, given the returns are trending downwards. To be more specific, the ROCE was 13% five years ago, but since then it has dropped noticeably. 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.

In Conclusion...

In summary, it's unfortunate that Japan Steel Works is generating lower returns from the same amount of capital. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 173%. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you're still interested in Japan Steel Works it's worth checking out our FREE intrinsic value approximation for 5631 to see if it's trading at an attractive price in other respects.

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.