Capital Allocation Trends At Kitagawa SeikiLtd (TSE:6327) Aren't Ideal

There are a few key trends to look for if we want to identify the next 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Kitagawa SeikiLtd (TSE:6327) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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What Is Return On Capital Employed (ROCE)?

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. The formula for this calculation on Kitagawa SeikiLtd is:

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

0.14 = JP¥771m ÷ (JP¥8.4b - JP¥2.8b) (Based on the trailing twelve months to March 2025).

Thus, Kitagawa SeikiLtd has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 8.5% it's much better.

View our latest analysis for Kitagawa SeikiLtd

In the above chart we have measured Kitagawa SeikiLtd's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Kitagawa SeikiLtd .

What Does the ROCE Trend For Kitagawa SeikiLtd Tell Us?

In terms of Kitagawa SeikiLtd's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 21%, but since then they've fallen to 14%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, Kitagawa SeikiLtd has decreased its current liabilities to 33% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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 Bottom Line

In summary, we're somewhat concerned by Kitagawa SeikiLtd's diminishing returns on increasing amounts of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 63% return 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.

Kitagawa SeikiLtd does have some risks though, and we've spotted 1 warning sign for Kitagawa SeikiLtd that you might be interested in.

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.