Sumitomo's (TSE:8053) Returns Have Hit A Wall

There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Sumitomo (TSE:8053) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. Analysts use this formula to calculate it for Sumitomo:

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

0.053 = JP¥415b ÷ (JP¥11t - JP¥3.1t) (Based on the trailing twelve months to March 2024).

Thus, Sumitomo has an ROCE of 5.3%. In absolute terms, that's a low return and it also under-performs the Trade Distributors industry average of 7.4%.

View our latest analysis for Sumitomo

In the above chart we have measured Sumitomo'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 Sumitomo .

What Does the ROCE Trend For Sumitomo Tell Us?

The returns on capital haven't changed much for Sumitomo in recent years. The company has consistently earned 5.3% for the last five years, and the capital employed within the business has risen 40% in that time. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.

In Conclusion...

As we've seen above, Sumitomo's returns on capital haven't increased but it is reinvesting in the business. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 220% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Sumitomo (of which 1 can't be ignored!) that you should know about.

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.