Is BroadBand Security (TYO:4398) Likely To Turn Things Around?

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. So while BroadBand Security (TYO:4398) has a high ROCE right now, lets see what we can decipher from how returns are changing.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for BroadBand Security:

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

0.22 = JP¥335m ÷ (JP¥2.5b - JP¥1.0b) (Based on the trailing twelve months to September 2020).

Thus, BroadBand Security has an ROCE of 22%. That's a fantastic return and not only that, it outpaces the average of 15% earned by companies in a similar industry.

View our latest analysis for BroadBand Security

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

What Does the ROCE Trend For BroadBand Security Tell Us?

On the surface, the trend of ROCE at BroadBand Security doesn't inspire confidence. To be more specific, while the ROCE is still high, it's fallen from 29% where it was four years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, BroadBand Security has done well to pay down its current liabilities to 41% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by BroadBand Security's reinvestment in its own business, we're aware that returns are shrinking. Although the market must be expecting these trends to improve because the stock has gained 29% over the last year. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One more thing, we've spotted 2 warning signs facing BroadBand Security that you might find interesting.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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