The Returns On Capital At Happiness and D (TYO:3174) Don't Inspire Confidence

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. Having said that, after a brief look, Happiness and D (TYO:3174) we aren't filled with optimism, but let's investigate further.

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 Happiness and D, this is the formula:

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

0.014 = JP¥89m ÷ (JP¥11b - JP¥4.8b) (Based on the trailing twelve months to November 2020).

Therefore, Happiness and D has an ROCE of 1.4%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 8.6%.

Check out our latest analysis for Happiness and D

Historical performance is a great place to start when researching a stock so above you can see the gauge for Happiness and D's ROCE against it's prior returns. If you'd like to look at how Happiness and D has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From Happiness and D's ROCE Trend?

We are a bit worried about the trend of returns on capital at Happiness and D. About five years ago, returns on capital were 3.4%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Happiness and D becoming one if things continue as they have.

On a separate but related note, it's important to know that Happiness and D has a current liabilities to total assets ratio of 42%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

In Conclusion...

In summary, it's unfortunate that Happiness and D is generating lower returns from the same amount of capital. In spite of that, the stock has delivered a 26% return to shareholders who held over the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

Happiness and D does have some risks, we noticed 2 warning signs (and 1 which can't be ignored) we think you should know about.

While Happiness and D isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. 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.
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