Forval (TSE:8275) Could Be Struggling To Allocate Capital

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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 Forval (TSE:8275) and its ROCE trend, we weren't exactly thrilled.

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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. Analysts use this formula to calculate it for Forval:

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

0.15 = JP¥3.8b ÷ (JP¥40b - JP¥16b) (Based on the trailing twelve months to December 2024).

So, Forval has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Electronic industry average of 9.0% it's much better.

Check out our latest analysis for Forval

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

What The Trend Of ROCE Can Tell Us

In terms of Forval's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 15% from 23% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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.

On a related note, Forval has decreased its current liabilities to 38% 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.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Forval's reinvestment in its own business, we're aware that returns are shrinking. And investors may be recognizing these trends since the stock has only returned a total of 27% to shareholders over the last five years. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

On a separate note, we've found 1 warning sign for Forval you'll probably want to know about.

While Forval 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.