If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Shigematsu Works (TYO:7980) and its ROCE trend, we weren't exactly thrilled.
Understanding 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 Shigematsu Works is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = JP¥762m ÷ (JP¥12b - JP¥5.3b) (Based on the trailing twelve months to September 2020).
Therefore, Shigematsu Works has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Commercial Services industry average of 7.7% it's much better.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Shigematsu Works' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Shigematsu Works, check out these free graphs here.
So How Is Shigematsu Works' ROCE Trending?
Over the past five years, Shigematsu Works' ROCE and capital employed have both remained mostly flat. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. With that in mind, unless investment picks up again in the future, we wouldn't expect Shigematsu Works to be a multi-bagger going forward.
On a separate but related note, it's important to know that Shigematsu Works has a current liabilities to total assets ratio of 43%, which we'd consider pretty high. 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.
The Bottom Line On Shigematsu Works' ROCE
We can conclude that in regards to Shigematsu Works' returns on capital employed and the trends, there isn't much change to report on. Although the market must be expecting these trends to improve because the stock has gained 76% over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
Shigematsu Works does have some risks though, and we've spotted 2 warning signs for Shigematsu Works that you might be interested in.
While Shigematsu Works may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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