Capital Allocation Trends At Sumco (TSE:3436) Aren't Ideal

If you're looking for a multi-bagger, there's a few things to keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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 Sumco (TSE:3436), we don't think it's current trends fit the mold of a multi-bagger.

Understanding 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. The formula for this calculation on Sumco is:

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

0.084 = JP¥73b ÷ (JP¥1.1t - JP¥205b) (Based on the trailing twelve months to December 2023).

So, Sumco has an ROCE of 8.4%. In absolute terms, that's a low return and it also under-performs the Semiconductor industry average of 12%.

Check out our latest analysis for Sumco

Above you can see how the current ROCE for Sumco compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Sumco .

What Can We Tell From Sumco's ROCE Trend?

On the surface, the trend of ROCE at Sumco doesn't inspire confidence. Around five years ago the returns on capital were 18%, but since then they've fallen to 8.4%. 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 may take some time before the company starts to see any change in earnings from these investments.

What We Can Learn From Sumco's ROCE

To conclude, we've found that Sumco is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 113% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

If you want to know some of the risks facing Sumco we've found 2 warning signs (1 can't be ignored!) that you should be aware of before investing here.

While Sumco 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.