Toray Industries (TSE:3402) Could Be Struggling To Allocate Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Toray Industries (TSE:3402) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

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. Analysts use this formula to calculate it for Toray Industries:

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

0.026 = JP¥65b ÷ (JP¥3.4t - JP¥890b) (Based on the trailing twelve months to December 2023).

Therefore, Toray Industries has an ROCE of 2.6%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 6.7%.

See our latest analysis for Toray Industries

In the above chart we have measured Toray Industries' 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 Toray Industries for free.

What Does the ROCE Trend For Toray Industries Tell Us?

In terms of Toray Industries' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 7.0%, but since then they've fallen to 2.6%. 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.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Toray Industries' reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 5.0% over the last five years, which potentially indicates that investors are accounting for this going forward. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

One more thing to note, we've identified 3 warning signs with Toray Industries and understanding them should be part of your investment process.

While Toray Industries may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.