Brains Technology (TSE:4075) Could Be Struggling To Allocate Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Brains Technology (TSE:4075) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Brains Technology is:

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

0.11 = JP¥172m ÷ (JP¥1.8b - JP¥241m) (Based on the trailing twelve months to October 2023).

So, Brains Technology has an ROCE of 11%. In isolation, that's a pretty standard return but against the Software industry average of 15%, it's not as good.

See our latest analysis for Brains Technology

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

The Trend Of ROCE

When we looked at the ROCE trend at Brains Technology, we didn't gain much confidence. To be more specific, ROCE has fallen from 16% over the last four years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Brains Technology has decreased its current liabilities to 14% 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.

The Bottom Line On Brains Technology's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Brains Technology is reinvesting for growth and has higher sales as a result. However, total returns to shareholders over the last year have been flat, which could indicate these growth trends potentially aren't accounted for yet by investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Brains Technology does have some risks, we noticed 2 warning signs (and 1 which can't be ignored) we think you should know about.

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.