The Returns On Capital At DHC SoftwareLtd (SZSE:002065) Don't Inspire Confidence

There are a few key trends to look for if we want to identify the next multi-bagger. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. Having said that, from a first glance at DHC SoftwareLtd (SZSE:002065) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for DHC SoftwareLtd:

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

0.049 = CN¥599m ÷ (CN¥24b - CN¥12b) (Based on the trailing twelve months to September 2024).

Thus, DHC SoftwareLtd has an ROCE of 4.9%. On its own that's a low return, but compared to the average of 3.7% generated by the IT industry, it's much better.

Check out our latest analysis for DHC SoftwareLtd

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

So How Is DHC SoftwareLtd's ROCE Trending?

On the surface, the trend of ROCE at DHC SoftwareLtd doesn't inspire confidence. Around five years ago the returns on capital were 9.5%, but since then they've fallen to 4.9%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

Another thing to note, DHC SoftwareLtd has a high ratio of current liabilities to total assets of 49%. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From DHC SoftwareLtd's ROCE

Bringing it all together, while we're somewhat encouraged by DHC SoftwareLtd's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 16% over the last five years, investors may not be too optimistic on this trend improving either. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

DHC SoftwareLtd does have some risks, we noticed 3 warning signs (and 1 which is concerning) we think you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.