StemCell Institute's (TSE:7096) Returns On Capital Not Reflecting Well On The Business

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Although, when we looked at StemCell Institute (TSE:7096), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for StemCell Institute, this is the formula:

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

0.16 = JP¥448m ÷ (JP¥6.7b - JP¥3.8b) (Based on the trailing twelve months to June 2024).

So, StemCell Institute has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 9.2% generated by the Healthcare industry.

Check out our latest analysis for StemCell Institute

In the above chart we have measured StemCell Institute's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering StemCell Institute for free.

What Can We Tell From StemCell Institute's ROCE Trend?

When we looked at the ROCE trend at StemCell Institute, we didn't gain much confidence. Around five years ago the returns on capital were 24%, but since then they've fallen to 16%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

Another thing to note, StemCell Institute has a high ratio of current liabilities to total assets of 57%. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From StemCell Institute's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that StemCell Institute is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 40% over the last three years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One more thing to note, we've identified 1 warning sign with StemCell Institute and understanding it should be part of your investment process.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.