If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. So after we looked into Seki (TYO:7857), the trends above didn't look too great.
Understanding 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. Analysts use this formula to calculate it for Seki:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0038 = JP¥57m ÷ (JP¥16b - JP¥1.6b) (Based on the trailing twelve months to September 2020).
Therefore, Seki has an ROCE of 0.4%. Ultimately, that's a low return and it under-performs the Commercial Services industry average of 8.1%.
View our latest analysis for Seki
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're interested in investigating Seki's past further, check out this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
There is reason to be cautious about Seki, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 4.7% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Seki becoming one if things continue as they have.
What We Can Learn From Seki's ROCE
In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Investors must expect better things on the horizon though because the stock has risen 21% in the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
Seki does have some risks, we noticed 4 warning signs (and 1 which shouldn't be ignored) 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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This article by Simply Wall St is general in nature. 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.
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About TSE:7857
Flawless balance sheet average dividend payer.
