Returns On Capital Signal Tricky Times Ahead For Linkage Software (SHSE:688588)

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Linkage Software (SHSE:688588) 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. The formula for this calculation on Linkage Software is:

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

0.08 = CN¥99m ÷ (CN¥1.6b - CN¥393m) (Based on the trailing twelve months to March 2024).

Therefore, Linkage Software has an ROCE of 8.0%. On its own that's a low return, but compared to the average of 3.0% generated by the Software industry, it's much better.

View our latest analysis for Linkage Software

Historical performance is a great place to start when researching a stock so above you can see the gauge for Linkage Software's ROCE against it's prior returns. If you'd like to look at how Linkage Software has performed in the past in other metrics, you can view this free graph of Linkage Software's past earnings, revenue and cash flow.

How Are Returns Trending?

In terms of Linkage Software's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 12%, but since then they've fallen to 8.0%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Linkage Software's current liabilities have increased over the last five years to 24% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 8.0%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

The Bottom Line

While returns have fallen for Linkage Software in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These growth trends haven't led to growth returns though, since the stock has fallen 59% over the last three years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you want to know some of the risks facing Linkage Software we've found 4 warning signs (1 is concerning!) that you should be aware of before investing here.

While Linkage Software 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.