Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This indicates the company is producing less profit from its investments and its total assets are decreasing. On that note, looking into Sakae Electronics (TYO:7567), we weren't too upbeat about how things were going.
Understanding Return On Capital Employed (ROCE)
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. To calculate this metric for Sakae Electronics, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.031 = JP¥94m ÷ (JP¥5.2b - JP¥2.2b) (Based on the trailing twelve months to September 2020).
Thus, Sakae Electronics has an ROCE of 3.1%. Ultimately, that's a low return and it under-performs the Electronic industry average of 7.1%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Sakae Electronics' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Sakae Electronics, check out these free graphs here.
What Does the ROCE Trend For Sakae Electronics Tell Us?
There is reason to be cautious about Sakae Electronics, given the returns are trending downwards. To be more specific, the ROCE was 4.7% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Sakae Electronics to turn into a multi-bagger.
On a side note, Sakae Electronics' current liabilities are still rather high at 42% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
Our Take On Sakae Electronics' ROCE
In summary, it's unfortunate that Sakae Electronics is generating lower returns from the same amount of capital. Since the stock has skyrocketed 301% over the last five years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
One more thing: We've identified 2 warning signs with Sakae Electronics (at least 1 which is significant) , and understanding them would certainly be useful.
While Sakae Electronics may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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