What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating DHC SoftwareLtd (SZSE:002065), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for DHC SoftwareLtd, this is the formula:

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

0.041 = CN¥502m ÷ (CN¥23b - CN¥11b) (Based on the trailing twelve months to March 2024).

Therefore, DHC SoftwareLtd has an ROCE of 4.1%. On its own that's a low return on capital but it's in line with the industry's average returns of 3.9%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for DHC SoftwareLtd's ROCE against it's prior returns. If you're interested in investigating DHC SoftwareLtd's past further, check out this free graph covering DHC SoftwareLtd's past earnings, revenue and cash flow.

So How Is DHC SoftwareLtd's ROCE Trending?

On the surface, the trend of ROCE at DHC SoftwareLtd doesn't inspire confidence. Over the last five years, returns on capital have decreased to 4.1% from 9.0% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

Another thing to note, DHC SoftwareLtd has a high ratio of current liabilities to total assets of 47%. 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.

In Conclusion...

In summary, DHC SoftwareLtd is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And in the last five years, the stock has given away 35% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think DHC SoftwareLtd has the makings of a multi-bagger.

One final note, you should learn about the 3 warning signs we've spotted with DHC SoftwareLtd (including 1 which is a bit unpleasant) .

While DHC SoftwareLtd 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. 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