Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Linewell Software (SHSE:603636) and its ROCE trend, we weren't exactly thrilled.
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. The formula for this calculation on Linewell Software is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.025 = CN¥70m ÷ (CN¥5.7b - CN¥2.9b) (Based on the trailing twelve months to September 2023).
Therefore, Linewell Software has an ROCE of 2.5%. On its own, that's a low figure but it's around the 2.7% average generated by the Software industry.
See our latest analysis for Linewell Software
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 want to delve into the historical earnings, revenue and cash flow of Linewell Software, check out these free graphs here.
What The Trend Of ROCE Can Tell Us
In terms of Linewell Software's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 2.5% from 11% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 51%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.
The Key Takeaway
To conclude, we've found that Linewell Software is reinvesting in the business, but returns have been falling. Unsurprisingly, the stock has only gained 23% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
If you want to know some of the risks facing Linewell Software we've found 4 warning signs (2 are a bit unpleasant!) that you should be aware of before investing here.
While Linewell Software 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.