How Has Toyo Drilube (TYO:4976) Allocated Its Capital?

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. In light of that, from a first glance at Toyo Drilube (TYO:4976), we've spotted some signs that it could be struggling, so let's investigate.

Return On Capital Employed (ROCE): What is it?

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 Toyo Drilube is:

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

0.024 = JP¥193m ÷ (JP¥9.3b - JP¥1.3b) (Based on the trailing twelve months to December 2020).

So, Toyo Drilube has an ROCE of 2.4%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 6.4%.

Check out our latest analysis for Toyo Drilube

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

How Are Returns Trending?

We are a bit worried about the trend of returns on capital at Toyo Drilube. To be more specific, the ROCE was 3.2% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Toyo Drilube becoming one if things continue as they have.

The Bottom Line On Toyo Drilube's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 128%. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Like most companies, Toyo Drilube does come with some risks, and we've found 1 warning sign that you should be aware of.

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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