What financial metrics can indicate to us that a company is maturing or even in decline? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that’s often how a mature business shows signs of aging. Ultimately this means that the company is earning less per dollar invested and on top of that, it’s shrinking its base of capital employed. And from a first read, things don’t look too good at Shinden Hightex (TYO:3131), so let’s see why.
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 Shinden Hightex:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.06 = JP¥452m ÷ (JP¥19b – JP¥12b) (Based on the trailing twelve months to June 2020).
Thus, Shinden Hightex has an ROCE of 6.0%. In absolute terms, that’s a low return but it’s around the Electronic industry average of 7.2%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Shinden Hightex’s ROCE against it’s prior returns. If you’re interested in investigating Shinden Hightex’s past further, check out this free graph of past earnings, revenue and cash flow.
What Can We Tell From Shinden Hightex’s ROCE Trend?
There is reason to be cautious about Shinden Hightex, given the returns are trending downwards. About five years ago, returns on capital were 8.9%, 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. Since returns are falling and the business has the same amount of assets employed, this can suggest it’s a mature business that hasn’t had much growth in the last five years. So because these trends aren’t typically conducive to creating a multi-bagger, we wouldn’t hold our breath on Shinden Hightex becoming one if things continue as they have.
On a separate but related note, it’s important to know that Shinden Hightex has a current liabilities to total assets ratio of 61%, which we’d consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it’s not necessarily a bad thing, it can be beneficial if this ratio is lower.
The Key Takeaway
In the end, the trend of lower returns on the same amount of capital isn’t typically an indication that we’re looking at a growth stock. Investors haven’t taken kindly to these developments, since the stock has declined 24% from where it was five years ago. With underlying trends that aren’t great in these areas, we’d consider looking elsewhere.
If you want to know some of the risks facing Shinden Hightex we’ve found 4 warning signs (1 can’t be ignored!) that you should be aware of before investing here.
While Shinden Hightex 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. 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.
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