Some Investors May Be Worried About Kao's (TSE:4452) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Kao (TSE:4452) 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 Kao, this is the formula:

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

0.046 = JP¥60b ÷ (JP¥1.8t - JP¥460b) (Based on the trailing twelve months to December 2023).

Thus, Kao has an ROCE of 4.6%. Ultimately, that's a low return and it under-performs the Personal Products industry average of 11%.

View our latest analysis for Kao

In the above chart we have measured Kao'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 Kao for free.

How Are Returns Trending?

On the surface, the trend of ROCE at Kao doesn't inspire confidence. Around five years ago the returns on capital were 21%, but since then they've fallen to 4.6%. However it looks like Kao might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

Our Take On Kao's ROCE

To conclude, we've found that Kao is reinvesting in the business, but returns have been falling. And investors appear hesitant that the trends will pick up because the stock has fallen 27% in the last five years. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

One more thing to note, we've identified 2 warning signs with Kao and understanding these should be part of your investment process.

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. 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.