Here's What's Concerning About Okamoto Machine Tool Works' (TSE:6125) Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Okamoto Machine Tool Works (TSE:6125), we don't think it's current trends fit the mold of a multi-bagger.

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What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Okamoto Machine Tool Works:

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

0.085 = JP¥4.0b ÷ (JP¥68b - JP¥21b) (Based on the trailing twelve months to December 2024).

Thus, Okamoto Machine Tool Works has an ROCE of 8.5%. In absolute terms, that's a low return but it's around the Machinery industry average of 7.9%.

Check out our latest analysis for Okamoto Machine Tool Works

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

What Can We Tell From Okamoto Machine Tool Works' ROCE Trend?

Unfortunately, the trend isn't great with ROCE falling from 19% five years ago, while capital employed has grown 156%. That being said, Okamoto Machine Tool Works raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. Okamoto Machine Tool Works probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

On a side note, Okamoto Machine Tool Works has done well to pay down its current liabilities to 31% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Okamoto Machine Tool Works' reinvestment in its own business, we're aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 135% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

One final note, you should learn about the 2 warning signs we've spotted with Okamoto Machine Tool Works (including 1 which is potentially serious) .

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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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.