Here's What's Concerning About Kohoku KogyoLTD's (TSE:6524) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Kohoku KogyoLTD (TSE:6524), it didn't seem to tick all of these boxes.

What Is 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. The formula for this calculation on Kohoku KogyoLTD is:

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

0.13 = JP¥2.8b ÷ (JP¥25b - JP¥2.5b) (Based on the trailing twelve months to December 2023).

Therefore, Kohoku KogyoLTD has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Electronic industry average of 9.6% it's much better.

See our latest analysis for Kohoku KogyoLTD

In the above chart we have measured Kohoku KogyoLTD's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Kohoku KogyoLTD .

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Kohoku KogyoLTD doesn't inspire confidence. To be more specific, ROCE has fallen from 18% over the last four years. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Kohoku KogyoLTD has decreased its current liabilities to 10% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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 Kohoku KogyoLTD's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Kohoku KogyoLTD have fallen, meanwhile the business is employing more capital than it was four years ago. However the stock has delivered a 11% return to shareholders over the last year, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Kohoku KogyoLTD does have some risks though, and we've spotted 1 warning sign for Kohoku KogyoLTD that you might be interested in.

While Kohoku KogyoLTD 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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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.