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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. 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)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its 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)
0.06 = CN¥76m ÷ (CN¥1.7b - CN¥443m) (Based on the trailing twelve months to September 2024).
Therefore, Hydsoft TechnologyLtd has an ROCE of 6.0%. On its own that's a low return, but compared to the average of 3.7% generated by the IT industry, it's much better.
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're interested in investigating Hydsoft TechnologyLtd's past further, check out this free graph covering Hydsoft TechnologyLtd's past earnings, revenue and cash flow.
So How Is Hydsoft TechnologyLtd's ROCE Trending?
We weren't thrilled with the trend because Hydsoft TechnologyLtd's ROCE has reduced by 63% over the last five years, while the business employed 439% more capital. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Hydsoft TechnologyLtd might not have received a full period of earnings contribution from it.
On a related note, Hydsoft TechnologyLtd has decreased its current liabilities to 26% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
What We Can Learn From Hydsoft TechnologyLtd's ROCE
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. However, despite the promising trends, the stock has fallen 27% over the last year, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.
Hydsoft TechnologyLtd does have some risks, we noticed 2 warning signs (and 1 which shouldn't be ignored) we think 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.
