What underlying fundamental trends can indicate that a company might be in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. And from a first read, things don't look too good at Sobal (TYO:2186), so let's see why.
Return On Capital Employed (ROCE): What is it?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Sobal, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = JP¥414m ÷ (JP¥4.1b - JP¥790m) (Based on the trailing twelve months to August 2020).
So, Sobal has an ROCE of 13%. That's a relatively normal return on capital, and it's around the 15% generated by the Software industry.
View our latest analysis for Sobal
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Sobal, check out these free graphs here.
So How Is Sobal's ROCE Trending?
We are a bit worried about the trend of returns on capital at Sobal. To be more specific, the ROCE was 21% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 Sobal becoming one if things continue as they have.
The Bottom Line On Sobal's ROCE
In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 66% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
Sobal does have some risks though, and we've spotted 2 warning signs for Sobal that you might be interested in.
While Sobal 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. 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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About TSE:2186
Sobal
Engages in the development of embedded software for digital appliances in Japan.
Flawless balance sheet with solid track record and pays a dividend.
