There Are Reasons To Feel Uneasy About Guo Tai Epoint SoftwareLtd's (SHSE:688232) Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Guo Tai Epoint SoftwareLtd (SHSE:688232) and its ROCE trend, we weren't exactly thrilled.

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. The formula for this calculation on Guo Tai Epoint SoftwareLtd is:

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

0.039 = CN¥209m ÷ (CN¥6.4b - CN¥937m) (Based on the trailing twelve months to December 2024).

So, Guo Tai Epoint SoftwareLtd has an ROCE of 3.9%. In absolute terms, that's a low return, but it's much better than the Software industry average of 2.9%.

See our latest analysis for Guo Tai Epoint SoftwareLtd

In the above chart we have measured Guo Tai Epoint SoftwareLtd's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Guo Tai Epoint SoftwareLtd .

The Trend Of ROCE

On the surface, the trend of ROCE at Guo Tai Epoint SoftwareLtd doesn't inspire confidence. Over the last five years, returns on capital have decreased to 3.9% from 47% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Guo Tai Epoint SoftwareLtd has done well to pay down its current liabilities to 15% of total assets. Since the ratio used to be 66%, that's a significant reduction and it no doubt explains the drop in ROCE. 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.

What We Can Learn From Guo Tai Epoint SoftwareLtd's ROCE

In summary, we're somewhat concerned by Guo Tai Epoint SoftwareLtd's diminishing returns on increasing amounts of capital. It should come as no surprise then that the stock has fallen 13% over the last three years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you'd like to know about the risks facing Guo Tai Epoint SoftwareLtd, we've discovered 1 warning sign that you should be aware of.

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.