LEOCLANLtd (TSE:7681) Might Be Having Difficulty Using Its Capital Effectively

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. Although, when we looked at LEOCLANLtd (TSE:7681), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

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 LEOCLANLtd, this is the formula:

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

0.027 = JP¥178m ÷ (JP¥11b - JP¥4.0b) (Based on the trailing twelve months to September 2024).

Therefore, LEOCLANLtd has an ROCE of 2.7%. Ultimately, that's a low return and it under-performs the Healthcare industry average of 8.2%.

Check out our latest analysis for LEOCLANLtd

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 LEOCLANLtd's past further, check out this free graph covering LEOCLANLtd's past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at LEOCLANLtd, we didn't gain much confidence. Around five years ago the returns on capital were 22%, but since then they've fallen to 2.7%. 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.

On a side note, LEOCLANLtd has done well to pay down its current liabilities to 37% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From LEOCLANLtd's ROCE

In summary, we're somewhat concerned by LEOCLANLtd's diminishing returns on increasing amounts of capital. Despite the concerning underlying trends, the stock has actually gained 13% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 5 warning signs for LEOCLANLtd (of which 3 are potentially serious!) that you should know about.

While LEOCLANLtd 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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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.