The Returns On Capital At Tosoh (TSE:4042) Don't Inspire Confidence

There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Tosoh (TSE:4042), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Tosoh:

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

0.084 = JP¥75b ÷ (JP¥1.3t - JP¥369b) (Based on the trailing twelve months to December 2023).

Therefore, Tosoh has an ROCE of 8.4%. In absolute terms, that's a low return, but it's much better than the Chemicals industry average of 6.8%.

View our latest analysis for Tosoh

In the above chart we have measured Tosoh's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Tosoh .

What Does the ROCE Trend For Tosoh Tell Us?

When we looked at the ROCE trend at Tosoh, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 8.4% from 19% five years ago. However it looks like Tosoh might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Tosoh's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 39% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

One more thing to note, we've identified 2 warning signs with Tosoh and understanding these should be part of your investment process.

While Tosoh 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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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.