What Do The Returns At Cluster Technology (TYO:4240) Mean Going Forward?

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. With that in mind, we've noticed some promising trends at Cluster Technology (TYO:4240) so let's look a bit deeper.

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. To calculate this metric for Cluster Technology, this is the formula:

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

0.013 = JP¥17m ÷ (JP¥1.4b - JP¥86m) (Based on the trailing twelve months to September 2020).

So, Cluster Technology has an ROCE of 1.3%. In absolute terms, that's a low return and it also under-performs the Electronic industry average of 7.0%.

View our latest analysis for Cluster Technology

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

How Are Returns Trending?

Shareholders will be relieved that Cluster Technology has broken into profitability. While the business was unprofitable in the past, it's now turned things around and is earning 1.3% on its capital. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. So while we're happy that the business is more efficient, just keep in mind that could mean that going forward the business is lacking areas to invest internally for growth. So if you're looking for high growth, you'll want to see a business's capital employed also increasing.

The Key Takeaway

In summary, we're delighted to see that Cluster Technology has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Given the stock has declined 25% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. With that in mind, we believe the promising trends warrant this stock for further investigation.

If you'd like to know about the risks facing Cluster Technology, we've discovered 1 warning sign that you should be aware of.

While Cluster Technology 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. 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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