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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at DHC SoftwareLtd (SZSE:002065) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Understanding 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)
0.027 = CN¥324m ÷ (CN¥23b - CN¥11b) (Based on the trailing twelve months to September 2023).
Therefore, DHC SoftwareLtd has an ROCE of 2.7%. Ultimately, that's a low return and it under-performs the IT industry average of 3.8%.
View our latest analysis for DHC SoftwareLtd
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'd like to look at how DHC SoftwareLtd has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For DHC SoftwareLtd Tell Us?
When we looked at the ROCE trend at DHC SoftwareLtd, we didn't gain much confidence. Around five years ago the returns on capital were 11%, but since then they've fallen to 2.7%. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
Our Take On DHC SoftwareLtd's ROCE
Bringing it all together, while we're somewhat encouraged by DHC SoftwareLtd's reinvestment in its own business, we're aware that returns are shrinking. Additionally, the stock's total return to shareholders over the last five years has been flat, which isn't too surprising. Therefore based on the analysis done in this article, we don't think DHC SoftwareLtd has the makings of a multi-bagger.
If you'd like to know more about DHC SoftwareLtd, we've spotted 3 warning signs, and 1 of them is potentially serious.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.