East Japan Railway's (TSE:9020) Returns On Capital Tell Us There Is Reason To Feel Uneasy

When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. On that note, looking into East Japan Railway (TSE:9020), we weren't too upbeat about how things were going.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for East Japan Railway, this is the formula:

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

0.047 = JP¥386b ÷ (JP¥9.6t - JP¥1.4t) (Based on the trailing twelve months to June 2024).

Thus, East Japan Railway has an ROCE of 4.7%. Even though it's in line with the industry average of 5.1%, it's still a low return by itself.

View our latest analysis for East Japan Railway

Above you can see how the current ROCE for East Japan Railway compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering East Japan Railway for free.

What Can We Tell From East Japan Railway's ROCE Trend?

We are a bit worried about the trend of returns on capital at East Japan Railway. About five years ago, returns on capital were 7.1%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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 East Japan Railway to turn into a multi-bagger.

In Conclusion...

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. And long term shareholders have watched their investments stay flat over the last five years. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

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

While East Japan Railway isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.