Our Take On The Returns On Capital At Tokatsu Holdings (TYO:2754)

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. However, after investigating Tokatsu Holdings (TYO:2754), we don't think it's current trends fit the mold of a multi-bagger.

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 Tokatsu Holdings is:

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

0.062 = JP¥296m ÷ (JP¥6.6b - JP¥1.8b) (Based on the trailing twelve months to September 2020).

So, Tokatsu Holdings has an ROCE of 6.2%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 9.1%.

Check out our latest analysis for Tokatsu Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Tokatsu Holdings' ROCE against it's prior returns. If you're interested in investigating Tokatsu Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

So How Is Tokatsu Holdings' ROCE Trending?

When we looked at the ROCE trend at Tokatsu Holdings, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 6.2% from 11% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Tokatsu Holdings has done well to pay down its current liabilities to 28% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

In Conclusion...

In summary, we're somewhat concerned by Tokatsu Holdings' diminishing returns on increasing amounts of capital. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 43% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

On a final note, we found 2 warning signs for Tokatsu Holdings (1 doesn't sit too well with us) you should be aware of.

While Tokatsu Holdings 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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