Nippon Chemical Industrial (TSE:4092) Could Be Struggling To Allocate Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 Nippon Chemical Industrial (TSE:4092), 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. The formula for this calculation on Nippon Chemical Industrial is:

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

0.04 = JP¥2.2b ÷ (JP¥77b - JP¥20b) (Based on the trailing twelve months to March 2024).

Therefore, Nippon Chemical Industrial has an ROCE of 4.0%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 6.5%.

See our latest analysis for Nippon Chemical Industrial

Above you can see how the current ROCE for Nippon Chemical Industrial compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Nippon Chemical Industrial .

What Does the ROCE Trend For Nippon Chemical Industrial Tell Us?

In terms of Nippon Chemical Industrial's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 6.6%, but since then they've fallen to 4.0%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

The Bottom Line On Nippon Chemical Industrial's ROCE

Bringing it all together, while we're somewhat encouraged by Nippon Chemical Industrial's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 55% over the last five years, 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.

One more thing to note, we've identified 1 warning sign with Nippon Chemical Industrial and understanding it should be part of your investment process.

While Nippon Chemical Industrial 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com