Be Wary Of Songwon Industrial (KRX:004430) And Its Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Songwon Industrial (KRX:004430) 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 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. The formula for this calculation on Songwon Industrial is:

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

0.066 = ₩52b ÷ (₩1.1t - ₩337b) (Based on the trailing twelve months to March 2024).

So, Songwon Industrial has an ROCE of 6.6%. On its own that's a low return on capital but it's in line with the industry's average returns of 6.6%.

See our latest analysis for Songwon Industrial

Historical performance is a great place to start when researching a stock so above you can see the gauge for Songwon Industrial's ROCE against it's prior returns. If you'd like to look at how Songwon Industrial has performed in the past in other metrics, you can view this free graph of Songwon Industrial's past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at Songwon Industrial, we didn't gain much confidence. To be more specific, ROCE has fallen from 10% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Songwon Industrial has done well to pay down its current liabilities to 30% 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

In summary, we're somewhat concerned by Songwon Industrial's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 38% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you'd like to know about the risks facing Songwon Industrial, we've discovered 2 warning signs that you should be aware of.

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.

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