These Return Metrics Don't Make Softchoice (TSE:SFTC) Look Too Strong

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. And from a first read, things don't look too good at Softchoice (TSE:SFTC), so let's see why.

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 Softchoice:

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

0.03 = US$5.6m ÷ (US$541m - US$355m) (Based on the trailing twelve months to March 2022).

So, Softchoice has an ROCE of 3.0%. In absolute terms, that's a low return and it also under-performs the Electronic industry average of 11%.

View our latest analysis for Softchoice

In the above chart we have measured Softchoice's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Softchoice here for free.

How Are Returns Trending?

We are a bit anxious about the trends of ROCE at Softchoice. To be more specific, today's ROCE was 8.6% two years ago but has since fallen to 3.0%. What's equally concerning is that the amount of capital deployed in the business has shrunk by 23% over that same period. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. If these underlying trends continue, we wouldn't be too optimistic going forward.

On a side note, Softchoice's current liabilities are still rather high at 66% of total assets. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From Softchoice's ROCE

In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. And, the stock has remained flat over the last year, so investors don't seem too impressed either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

On a separate note, we've found 1 warning sign for Softchoice you'll probably want to know about.

While Softchoice isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.