What We Make Of EnchoLtd's (TYO:8208) Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at EnchoLtd (TYO:8208) and its trend of ROCE, we really liked what we saw.

What is Return On Capital Employed (ROCE)?

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 EnchoLtd, this is the formula:

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

0.042 = JP¥809m ÷ (JP¥36b - JP¥17b) (Based on the trailing twelve months to September 2020).

So, EnchoLtd has an ROCE of 4.2%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 8.6%.

See our latest analysis for EnchoLtd

Historical performance is a great place to start when researching a stock so above you can see the gauge for EnchoLtd's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of EnchoLtd, check out these free graphs here.

What Can We Tell From EnchoLtd's ROCE Trend?

While the ROCE isn't as high as some other companies out there, it's great to see it's on the up. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 80% in that same time. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.

On a separate but related note, it's important to know that EnchoLtd has a current liabilities to total assets ratio of 47%, 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

To sum it up, EnchoLtd is collecting higher returns from the same amount of capital, and that's impressive. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 56% return over the last five years. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

One more thing: We've identified 5 warning signs with EnchoLtd (at least 2 which don't sit too well with us) , and understanding these would certainly be useful.

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.

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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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