Returns On Capital At Kohoku KogyoLTD (TSE:6524) Paint A Concerning Picture

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Kohoku KogyoLTD (TSE:6524) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the 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)

0.11 = JP¥2.6b ÷ (JP¥25b - JP¥2.5b) (Based on the trailing twelve months to March 2024).

Thus, Kohoku KogyoLTD has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 9.4% generated by the Electronic industry.

Check out 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 .

The Trend Of ROCE

In terms of Kohoku KogyoLTD's historical ROCE movements, the trend isn't fantastic. Around four years ago the returns on capital were 21%, but since then they've fallen to 11%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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 side note, Kohoku KogyoLTD has done well to pay down its current liabilities to 9.8% of total assets. So we could link some of this to the decrease in ROCE. 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 Kohoku KogyoLTD's ROCE

In summary, we're somewhat concerned by Kohoku KogyoLTD's diminishing returns on increasing amounts of capital. However the stock has delivered a 38% return to shareholders over the last year, so investors might be expecting the trends to turn around. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

If you want to continue researching Kohoku KogyoLTD, you might be interested to know about the 1 warning sign that our analysis has discovered.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.