Hokuetsu (TSE:3865) May Have Issues 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. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. Having said that, after a brief look, Hokuetsu (TSE:3865) we aren't filled with optimism, but let's investigate further.

What Is Return On Capital Employed (ROCE)?

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. To calculate this metric for Hokuetsu, this is the formula:

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

0.033 = JP¥11b ÷ (JP¥424b - JP¥86b) (Based on the trailing twelve months to June 2024).

So, Hokuetsu has an ROCE of 3.3%. Even though it's in line with the industry average of 3.3%, it's still a low return by itself.

See our latest analysis for Hokuetsu

Above you can see how the current ROCE for Hokuetsu compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Hokuetsu .

What The Trend Of ROCE Can Tell Us

There is reason to be cautious about Hokuetsu, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 4.6% that they were earning five years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Hokuetsu becoming one if things continue as they have.

The Bottom Line On Hokuetsu's ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Since the stock has skyrocketed 219% over the last five years, it looks like investors have high expectations of the stock. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you want to know some of the risks facing Hokuetsu we've found 3 warning signs (1 is a bit concerning!) that you should be aware of before investing here.

While Hokuetsu 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.