Be Wary Of AmifaLtd (TYO:7800) And Its Returns On Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at AmifaLtd (TYO:7800) 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 AmifaLtd, this is the formula:

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

0.11 = JP¥282m ÷ (JP¥3.0b - JP¥489m) (Based on the trailing twelve months to December 2020).

So, AmifaLtd has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Forestry industry average of 5.3% it's much better.

View our latest analysis for AmifaLtd

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

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at AmifaLtd, we didn't gain much confidence. Around three years ago the returns on capital were 14%, but since then they've fallen to 11%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, AmifaLtd has done well to pay down its current liabilities to 16% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On AmifaLtd's ROCE

To conclude, we've found that AmifaLtd is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 18% over the last year, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

If you'd like to know more about AmifaLtd, we've spotted 2 warning signs, and 1 of them doesn't sit too well with us.

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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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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