There Are Reasons To Feel Uneasy About Nippon Kayaku's (TSE:4272) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Nippon Kayaku (TSE:4272) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. To calculate this metric for Nippon Kayaku, this is the formula:

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

0.034 = JP¥11b ÷ (JP¥376b - JP¥66b) (Based on the trailing twelve months to June 2024).

So, Nippon Kayaku has an ROCE of 3.4%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 6.8%.

Check out our latest analysis for Nippon Kayaku

Above you can see how the current ROCE for Nippon Kayaku compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Nippon Kayaku for free.

How Are Returns Trending?

On the surface, the trend of ROCE at Nippon Kayaku doesn't inspire confidence. Over the last five years, returns on capital have decreased to 3.4% from 7.8% five years ago. 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'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.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Nippon Kayaku's reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 5.7% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

Nippon Kayaku does have some risks, we noticed 3 warning signs (and 1 which is significant) we think you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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

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.