If you’re not sure where to start when looking for the next multi-bagger, there are a few key trends you should watch out for. Among other things, we will want to see two things; first, growth come back on capital employed (ROCE) and on the other hand, an expansion of the amount capital employed. Ultimately, this demonstrates that this is a company that reinvests its earnings at increasing rates of return. That said, at a first glance at Software (ETR: SOW) we’re not jumping out of our chairs on the yield trend, but taking a closer look.
Understanding return on capital employed (ROCE)
Just to clarify if you’re not sure, ROCE is a measure of the pre-tax income (as a percentage) that a business earns on the capital invested in its business. Analysts use this formula to calculate it for software:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.039 = €86M ÷ (€2.8B – €531M) (Based on the last twelve months to September 2022).
Thereby, Software has a ROCE of 3.9%. In absolute terms, that’s a low return, and it’s also below the software industry average of 14%.
Above, you can see how the current ROCE for software compares to its past returns on capital, but you can’t tell much about the past. If you want, you can check analyst forecasts covering software here for free.
What is the return trend?
Unfortunately, the trend is not looking good with a ROCE down 16% five years ago, while capital employed increased by 73%. That being said, Software raised capital before its latest earnings release, which may partly explain the increase in capital employed. It is unlikely that all of the funds raised have already been contributed, so Software may not have received a full period of profit contribution from it.
Similarly, Software reduced its current liabilities to 19% of total assets. This could partly explain why ROCE fell. In effect, this means that their suppliers or short-term creditors finance the business less, which reduces certain elements of risk. Some would argue that this reduces the company’s effectiveness in generating a return on investment, as it now funds more of the operations with its own money.
ROCE of our Take On software
In conclusion, we found that Software is reinvesting in the business, but returns are declining. And investors seem hesitant about the trend picking up as the stock has fallen 37% in the past five years. Overall, we’re not overly inspired by the underlying trends and think there’s perhaps a better chance of finding a multi-bagger elsewhere.
If you want to know more about the software, we have spotted 2 warning signs, and 1 of them is potentially serious.
If you want to look for strong companies with excellent earnings, check out this free list of companies with strong balance sheets and impressive returns on equity.
Valuation is complex, but we help make it simple.
Find out if Software is potentially overvalued or undervalued by viewing our full analysis, which includes fair value estimates, risks and warnings, dividends, insider trading and financial health.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.