Should We Be Excited About The Trends Of Returns At Sato Foods Industries (TYO:2814)?

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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 Sato Foods Industries (TYO:2814) 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. To calculate this metric for Sato Foods Industries, this is the formula:

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

0.037 = JP¥653m ÷ (JP¥19b - JP¥1.8b) (Based on the trailing twelve months to December 2020).

Therefore, Sato Foods Industries has an ROCE of 3.7%. Ultimately, that's a low return and it under-performs the Food industry average of 7.1%.

Check out our latest analysis for Sato Foods Industries

Historical performance is a great place to start when researching a stock so above you can see the gauge for Sato Foods Industries' ROCE against it's prior returns. If you're interested in investigating Sato Foods Industries' past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

In terms of Sato Foods Industries' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 5.4%, but since then they've fallen to 3.7%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

The Bottom Line

In summary, we're somewhat concerned by Sato Foods Industries' diminishing returns on increasing amounts of capital. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 109%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

On a separate note, we've found 2 warning signs for Sato Foods Industries you'll probably want to know about.

While Sato Foods Industries isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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