Capital Allocation Trends At Topcon (TSE:7732) Aren't Ideal

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. In light of that, when we looked at Topcon (TSE:7732) and its ROCE trend, we weren't exactly thrilled.

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. The formula for this calculation on Topcon is:

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

0.073 = JP¥12b ÷ (JP¥234b - JP¥70b) (Based on the trailing twelve months to December 2023).

Therefore, Topcon has an ROCE of 7.3%. In absolute terms, that's a low return and it also under-performs the Electronic industry average of 9.6%.

Check out our latest analysis for Topcon

In the above chart we have measured Topcon's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Topcon .

What Can We Tell From Topcon's ROCE Trend?

When we looked at the ROCE trend at Topcon, we didn't gain much confidence. To be more specific, ROCE has fallen from 11% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

The Bottom Line On Topcon's ROCE

Bringing it all together, while we're somewhat encouraged by Topcon's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 44% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

On a final note, we found 4 warning signs for Topcon (2 are a bit unpleasant) you should be aware of.

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. 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.