What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Hydsoft TechnologyLtd (SZSE:301316) and its ROCE trend, we weren't exactly thrilled.

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. Analysts use this formula to calculate it for Hydsoft TechnologyLtd:

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

0.07 = CN¥80m ÷ (CN¥1.4b - CN¥288m) (Based on the trailing twelve months to September 2023).

Therefore, Hydsoft TechnologyLtd has an ROCE of 7.0%. On its own that's a low return, but compared to the average of 4.2% generated by the IT industry, it's much better.

View our latest analysis for Hydsoft TechnologyLtd

Historical performance is a great place to start when researching a stock so above you can see the gauge for Hydsoft TechnologyLtd's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Hydsoft TechnologyLtd, check out these free graphs here.

So How Is Hydsoft TechnologyLtd's ROCE Trending?

In terms of Hydsoft TechnologyLtd's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 21%, but since then they've fallen to 7.0%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Hydsoft TechnologyLtd has done well to pay down its current liabilities to 20% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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 Key Takeaway

While returns have fallen for Hydsoft TechnologyLtd in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These trends are starting to be recognized by investors since the stock has delivered a 5.4% gain to shareholders who've held over the last year. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

One more thing to note, we've identified 1 warning sign with Hydsoft TechnologyLtd and understanding it should be part of your investment process.

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

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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.