How Well Is Toyo Drilube (TYO:4976) Allocating Its Capital?

When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. And from a first read, things don't look too good at Toyo Drilube (TYO:4976), so let's see why.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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)

0.019 = JP¥147m ÷ (JP¥9.1b - JP¥1.2b) (Based on the trailing twelve months to September 2020).

So, Toyo Drilube has an ROCE of 1.9%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 6.3%.

See 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.

What Does the ROCE Trend For Toyo Drilube Tell Us?

There is reason to be cautious about Toyo Drilube, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 3.7% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. 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.

What We Can Learn From Toyo Drilube's ROCE

In summary, it's unfortunate that Toyo Drilube is generating lower returns from the same amount of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 59% return over the last five years, so investors appear very optimistic. 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 2 warning signs that you should be aware of.

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. 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.
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