Kanto Denka Kogyo (TSE:4047) Could Be Struggling To Allocate Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. Although, when we looked at Kanto Denka Kogyo (TSE:4047), it didn't seem to tick all of these boxes.

Understanding 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. Analysts use this formula to calculate it for Kanto Denka Kogyo:

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

0.024 = JP¥2.4b ÷ (JP¥132b - JP¥31b) (Based on the trailing twelve months to December 2023).

So, Kanto Denka Kogyo has an ROCE of 2.4%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 6.8%.

Check out our latest analysis for Kanto Denka Kogyo

Above you can see how the current ROCE for Kanto Denka Kogyo 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 Kanto Denka Kogyo .

The Trend Of ROCE

When we looked at the ROCE trend at Kanto Denka Kogyo, we didn't gain much confidence. To be more specific, ROCE has fallen from 17% over the last five years. However it looks like Kanto Denka Kogyo 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 On Kanto Denka Kogyo's ROCE

In summary, Kanto Denka Kogyo is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has gained an impressive 41% over the last five years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

One more thing to note, we've identified 1 warning sign with Kanto Denka Kogyo and understanding this should be part of your investment process.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.