If you're looking for a multi-bagger, there's a few things to keep an eye out for. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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 DHC SoftwareLtd (SZSE:002065), we don't think it's current trends fit the mold of a multi-bagger.

What Is Return On Capital Employed (ROCE)?

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. Analysts use this formula to calculate it for DHC SoftwareLtd:

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

0.049 = CN¥599m ÷ (CN¥24b - CN¥12b) (Based on the trailing twelve months to September 2024).

Therefore, DHC SoftwareLtd has an ROCE of 4.9%. In absolute terms, that's a low return, but it's much better than the IT industry average of 3.7%.

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.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at DHC SoftwareLtd, we didn't gain much confidence. To be more specific, ROCE has fallen from 9.5% over the last five years. 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.

On a separate but related note, it's important to know that DHC SoftwareLtd has a current liabilities to total assets ratio of 49%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From DHC SoftwareLtd's ROCE

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 investors appear hesitant that the trends will pick up because the stock has fallen 18% in the last five years. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

If you want to know some of the risks facing DHC SoftwareLtd we've found 3 warning signs (1 is a bit unpleasant!) that you should be aware of before investing here.

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.