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

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Linkage Software (SHSE:688588), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed 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)

0.11 = CN¥144m ÷ (CN¥1.8b - CN¥538m) (Based on the trailing twelve months to September 2024).

Therefore, Linkage Software has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Software industry average of 2.3% it's much better.

See 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.

What Does the ROCE Trend For Linkage Software Tell Us?

In terms of Linkage Software's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 18%, but since then they've fallen to 11%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Linkage Software's current liabilities have increased over the last five years to 30% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 11%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

Our Take On Linkage Software's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Linkage Software. However, total returns to shareholders over the last three years have been flat, which could indicate these growth trends potentially aren't accounted for yet by investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Linkage Software does come with some risks though, we found 4 warning signs in our investment analysis, and 3 of those make us uncomfortable...

While Linkage Software may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.