Here's What's Concerning About Goodpatch's (TSE:7351) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Goodpatch (TSE:7351) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding 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. Analysts use this formula to calculate it for Goodpatch:

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

0.017 = JP¥71m ÷ (JP¥4.6b - JP¥468m) (Based on the trailing twelve months to May 2024).

Thus, Goodpatch has an ROCE of 1.7%. In absolute terms, that's a low return and it also under-performs the IT industry average of 16%.

See our latest analysis for Goodpatch

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

So How Is Goodpatch's ROCE Trending?

When we looked at the ROCE trend at Goodpatch, we didn't gain much confidence. To be more specific, ROCE has fallen from 11% over the last five years. However it looks like Goodpatch might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Goodpatch has decreased its current liabilities to 10% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From Goodpatch's ROCE

In summary, Goodpatch is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. It seems that investors have little hope of these trends getting any better and that may have partly contributed to the stock collapsing 83% in the last three years. Therefore based on the analysis done in this article, we don't think Goodpatch has the makings of a multi-bagger.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Goodpatch (of which 1 is concerning!) that you should know about.

While Goodpatch isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.