Does Tohoku Steel's (TYO:5484) Returns On Capital Reflect Well On The Business?

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. On that note, looking into Tohoku Steel (TYO:5484), we weren't too upbeat about how things were going.

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

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Tohoku Steel is:

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

0.052 = JP¥1.4b ÷ (JP¥28b - JP¥2.3b) (Based on the trailing twelve months to September 2020).

So, Tohoku Steel has an ROCE of 5.2%. Even though it's in line with the industry average of 5.4%, it's still a low return by itself.

View our latest analysis for Tohoku Steel

Historical performance is a great place to start when researching a stock so above you can see the gauge for Tohoku Steel's ROCE against it's prior returns. If you'd like to look at how Tohoku Steel has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

In terms of Tohoku Steel's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 7.9%, however they're now substantially lower than that as we saw above. 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 Tohoku Steel becoming one if things continue as they have.

In Conclusion...

In summary, it's unfortunate that Tohoku Steel is generating lower returns from the same amount of capital. Despite the concerning underlying trends, the stock has actually gained 31% 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.

If you're still interested in Tohoku Steel it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.

While Tohoku Steel 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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