If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Hydsoft TechnologyLtd (SZSE:301316), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for Hydsoft TechnologyLtd, this is the formula:

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

0.067 = CN¥83m ÷ (CN¥1.5b - CN¥293m) (Based on the trailing twelve months to March 2024).

So, Hydsoft TechnologyLtd has an ROCE of 6.7%. In absolute terms, that's a low return, but it's much better than the IT industry average of 3.9%.

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Hydsoft TechnologyLtd has performed in the past in other metrics, you can view this free graph of Hydsoft TechnologyLtd's past earnings, revenue and cash flow.

The Trend Of ROCE

The trend of ROCE doesn't look fantastic because it's fallen from 19% five years ago, while the business's capital employed increased by 647%. Usually this isn't ideal, but given Hydsoft TechnologyLtd 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 Hydsoft TechnologyLtd's earnings and if they change as a result from the capital raise. Also, we found that by looking at the company's latest EBIT, the figure is within 10% of the previous year's EBIT so you can basically assign the ROCE drop primarily to that capital raise.

On a related note, Hydsoft TechnologyLtd has decreased its current liabilities to 19% of total assets. So we could link some of this to the decrease in ROCE. 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 Bottom Line

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 growth trends haven't led to growth returns though, since the stock has fallen 38% over the last year. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Hydsoft TechnologyLtd could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation for 301316 on our platform quite valuable.

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.

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