Techfirm Holdings (TSE:3625) May Have Issues Allocating Its Capital

When researching a stock for investment, what can tell us that the company is 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. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. And from a first read, things don't look too good at Techfirm Holdings (TSE:3625), so let's see why.

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. To calculate this metric for Techfirm Holdings, this is the formula:

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

0.012 = JP¥26m ÷ (JP¥3.9b - JP¥1.8b) (Based on the trailing twelve months to December 2023).

Thus, Techfirm Holdings has an ROCE of 1.2%. In absolute terms, that's a low return and it also under-performs the IT industry average of 16%.

See our latest analysis for Techfirm Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Techfirm Holdings' ROCE against it's prior returns. If you're interested in investigating Techfirm Holdings' past further, check out this free graph covering Techfirm Holdings' past earnings, revenue and cash flow.

How Are Returns Trending?

The trend of ROCE at Techfirm Holdings is showing some signs of weakness. Unfortunately, returns have declined substantially over the last five years to the 1.2% we see today. What's equally concerning is that the amount of capital deployed in the business has shrunk by 47% over that same period. The fact that both are shrinking is an indication that the business is going through some tough times. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 45%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 1.2%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Key Takeaway

In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. Long term shareholders who've owned the stock over the last five years have experienced a 46% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One final note, you should learn about the 3 warning signs we've spotted with Techfirm Holdings (including 2 which are potentially serious) .

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.