The Returns On Capital At SonocomLtd (TYO:7902) Don't Inspire Confidence

When researching a stock for investment, what can tell us that the company is in decline? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. Basically the company is earning less on its investments and it is also reducing its total assets. In light of that, from a first glance at SonocomLtd (TYO:7902), we've spotted some signs that it could be struggling, so let's investigate.

Understanding 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 SonocomLtd, this is the formula:

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

0.017 = JP¥138m ÷ (JP¥8.8b - JP¥396m) (Based on the trailing twelve months to September 2020).

Thus, SonocomLtd has an ROCE of 1.7%. Ultimately, that's a low return and it under-performs the Electronic industry average of 7.0%.

See our latest analysis for SonocomLtd

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

What The Trend Of ROCE Can Tell Us

In terms of SonocomLtd's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 3.0%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 SonocomLtd to turn into a multi-bagger.

In Conclusion...

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. In spite of that, the stock has delivered a 17% return to shareholders who held over the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

If you want to know some of the risks facing SonocomLtd we've found 3 warning signs (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

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. 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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