What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. So on that note, Koyou Rentia (TYO:7081) looks quite promising in regards to its trends of return on capital.
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. The formula for this calculation on Koyou Rentia is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.19 = JP¥1.4b ÷ (JP¥14b - JP¥6.8b) (Based on the trailing twelve months to December 2020).
Therefore, Koyou Rentia has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Commercial Services industry average of 8.1% it's much better.
Above you can see how the current ROCE for Koyou Rentia compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Koyou Rentia.
So How Is Koyou Rentia's ROCE Trending?
Koyou Rentia's ROCE growth is quite impressive. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 239% over the last three years. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.
Another thing to note, Koyou Rentia has a high ratio of current liabilities to total assets of 49%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
What We Can Learn From Koyou Rentia's ROCE
As discussed above, Koyou Rentia appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Since the stock has returned a solid 45% to shareholders over the last year, it's fair to say investors are beginning to recognize these changes. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
If you'd like to know about the risks facing Koyou Rentia, we've discovered 3 warning signs that you should be aware of.
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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