If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. With that in mind, we've noticed some promising trends at DrecomLtd (TSE:3793) so let's look a bit deeper.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on DrecomLtd is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.082 = JP¥826m ÷ (JP¥14b - JP¥3.7b) (Based on the trailing twelve months to June 2024).
Therefore, DrecomLtd has an ROCE of 8.2%. Ultimately, that's a low return and it under-performs the Entertainment industry average of 11%.
Check out our latest analysis for DrecomLtd
In the above chart we have measured DrecomLtd's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering DrecomLtd for free.
How Are Returns Trending?
The fact that DrecomLtd is now generating some pre-tax profits from its prior investments is very encouraging. The company was generating losses five years ago, but now it's earning 8.2% which is a sight for sore eyes. Not only that, but the company is utilizing 231% more capital than before, but that's to be expected from a company trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.
On a related note, the company's ratio of current liabilities to total assets has decreased to 27%, which basically reduces it's funding from the likes of short-term creditors or suppliers. So this improvement in ROCE has come from the business' underlying economics, which is great to see.
Our Take On DrecomLtd's ROCE
Overall, DrecomLtd gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 3.6% to shareholders. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.
One final note, you should learn about the 2 warning signs we've spotted with DrecomLtd (including 1 which makes us a bit uncomfortable) .
While DrecomLtd 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.
About TSE:3793
High growth potential with adequate balance sheet.
