What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Although, when we looked at Brother Enterprises HoldingLtd (SZSE:002562), it didn't seem to tick all of these boxes.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Brother Enterprises HoldingLtd, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.013 = CN¥47m ÷ (CN¥5.8b - CN¥2.1b) (Based on the trailing twelve months to September 2023).
Therefore, Brother Enterprises HoldingLtd has an ROCE of 1.3%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 5.7%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Brother Enterprises HoldingLtd's ROCE against it's prior returns. If you're interested in investigating Brother Enterprises HoldingLtd's past further, check out this free graph covering Brother Enterprises HoldingLtd's past earnings, revenue and cash flow.
So How Is Brother Enterprises HoldingLtd's ROCE Trending?
Unfortunately, the trend isn't great with ROCE falling from 9.5% five years ago, while capital employed has grown 30%. Usually this isn't ideal, but given Brother Enterprises HoldingLtd conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Brother Enterprises HoldingLtd's earnings and if they change as a result from the capital raise.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 36%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.
The Key Takeaway
In summary, we're somewhat concerned by Brother Enterprises HoldingLtd's diminishing returns on increasing amounts of capital. It should come as no surprise then that the stock has fallen 32% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Brother Enterprises HoldingLtd (of which 1 is concerning!) that you should know about.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.