Toho Gas (TSE:9533) Could Be Struggling To Allocate Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Toho Gas (TSE:9533) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding 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 Toho Gas is:

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

0.039 = JP¥25b ÷ (JP¥734b - JP¥80b) (Based on the trailing twelve months to June 2024).

Therefore, Toho Gas has an ROCE of 3.9%. In absolute terms, that's a low return and it also under-performs the Gas Utilities industry average of 5.8%.

View our latest analysis for Toho Gas

In the above chart we have measured Toho Gas' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Toho Gas for free.

How Are Returns Trending?

When we looked at the ROCE trend at Toho Gas, we didn't gain much confidence. Around five years ago the returns on capital were 5.5%, but since then they've fallen to 3.9%. 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.

Our Take On Toho Gas' ROCE

In summary, we're somewhat concerned by Toho Gas' diminishing returns on increasing amounts of capital. Despite the concerning underlying trends, the stock has actually gained 4.1% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Toho Gas (of which 1 makes us a bit uncomfortable!) that you should know about.

While Toho Gas 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.