SCREEN Holdings (TSE:7735) Knows How To Allocate Capital Effectively

There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Speaking of which, we noticed some great changes in SCREEN Holdings' (TSE:7735) returns on capital, so let's have a look.

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. The formula for this calculation on SCREEN Holdings is:

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

0.24 = JP¥94b ÷ (JP¥677b - JP¥286b) (Based on the trailing twelve months to March 2024).

Therefore, SCREEN Holdings has an ROCE of 24%. That's a fantastic return and not only that, it outpaces the average of 13% earned by companies in a similar industry.

View our latest analysis for SCREEN Holdings

In the above chart we have measured SCREEN Holdings' 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 SCREEN Holdings for free.

What Can We Tell From SCREEN Holdings' ROCE Trend?

We like the trends that we're seeing from SCREEN Holdings. Over the last five years, returns on capital employed have risen substantially to 24%. Basically the business is earning more per dollar of capital invested and in addition to that, 78% more capital is being employed now too. So we're very much inspired by what we're seeing at SCREEN Holdings thanks to its ability to profitably reinvest capital.

Another thing to note, SCREEN Holdings has a high ratio of current liabilities to total assets of 42%. 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.

What We Can Learn From SCREEN Holdings' ROCE

In summary, it's great to see that SCREEN Holdings can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

Like most companies, SCREEN Holdings does come with some risks, and we've found 2 warning signs that you should be aware of.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.