If we want to find a stock that could multiply over the long term, what are the underlying trends we should look 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Pansoft (SZSE:300996) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Pansoft:

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

0.086 = CN¥106m ÷ (CN¥1.4b - CN¥153m) (Based on the trailing twelve months to September 2024).

Therefore, Pansoft has an ROCE of 8.6%. In absolute terms, that's a low return, but it's much better than the Software industry average of 2.3%.

Above you can see how the current ROCE for Pansoft compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Pansoft .

What Can We Tell From Pansoft's ROCE Trend?

When we looked at the ROCE trend at Pansoft, we didn't gain much confidence. To be more specific, ROCE has fallen from 16% over the last five years. However it looks like Pansoft might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. 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 side note, Pansoft has done well to pay down its current liabilities to 11% of total assets. That could partly explain why the ROCE has dropped. 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. 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 Key Takeaway

To conclude, we've found that Pansoft is reinvesting in the business, but returns have been falling. And in the last three years, the stock has given away 20% so the market doesn't look too hopeful on these trends strengthening any time soon. 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.

One more thing to note, we've identified 1 warning sign with Pansoft and understanding this should be part of your investment process.

While Pansoft 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.