What Do The Returns On Capital At TOSNET (TYO:4754) Tell Us?

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. Although, when we looked at TOSNET (TYO:4754), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on TOSNET is:

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

0.064 = JP¥432m ÷ (JP¥8.7b - JP¥1.9b) (Based on the trailing twelve months to September 2020).

So, TOSNET has an ROCE of 6.4%. On its own, that's a low figure but it's around the 7.7% average generated by the Commercial Services industry.

View our latest analysis for TOSNET

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how TOSNET has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From TOSNET's ROCE Trend?

When we looked at the ROCE trend at TOSNET, we didn't gain much confidence. Around five years ago the returns on capital were 20%, but since then they've fallen to 6.4%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by TOSNET's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 2.5% over the last five years, which potentially indicates that investors are accounting for this going forward. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

TOSNET does have some risks, we noticed 4 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

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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