Returns On Capital Are Showing Encouraging Signs At IHI (TSE:7013)

What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we've noticed some promising trends at IHI (TSE:7013) so let's look a bit deeper.

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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. To calculate this metric for IHI, this is the formula:

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

0.13 = JP¥136b ÷ (JP¥2.3t - JP¥1.2t) (Based on the trailing twelve months to December 2024).

Therefore, IHI has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 7.8% it's much better.

Check out our latest analysis for IHI

Above you can see how the current ROCE for IHI 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 IHI for free.

What Does the ROCE Trend For IHI Tell Us?

Investors would be pleased with what's happening at IHI. Over the last five years, returns on capital employed have risen substantially to 13%. Basically the business is earning more per dollar of capital invested and in addition to that, 28% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

Another thing to note, IHI has a high ratio of current liabilities to total assets of 53%. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Key Takeaway

To sum it up, IHI has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

On a final note, we've found 3 warning signs for IHI that we think you should be aware of.

While IHI isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.