Here's What's Concerning About Hydsoft TechnologyLtd's (SZSE:301316) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Hydsoft TechnologyLtd (SZSE:301316), we don't think it's current trends fit the mold of a multi-bagger.

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. The formula for this calculation on Hydsoft TechnologyLtd is:

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

0.059 = CN¥74m ÷ (CN¥1.7b - CN¥443m) (Based on the trailing twelve months to September 2024).

Therefore, Hydsoft TechnologyLtd has an ROCE of 5.9%. 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 Hydsoft TechnologyLtd

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Hydsoft TechnologyLtd's past further, check out this free graph covering Hydsoft TechnologyLtd's past earnings, revenue and cash flow.

How Are Returns Trending?

We weren't thrilled with the trend because Hydsoft TechnologyLtd's ROCE has reduced by 64% over the last five years, while the business employed 439% more capital. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Hydsoft TechnologyLtd might not have received a full period of earnings contribution from it. It's also worth noting the company's latest EBIT figure is within 10% of the previous year, so it's fair to assign the ROCE drop largely to the capital raise.

On a side note, Hydsoft TechnologyLtd has done well to pay down its current liabilities to 26% of total assets. That could partly explain why the ROCE has dropped. 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.

In Conclusion...

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Hydsoft TechnologyLtd. These trends don't appear to have influenced returns though, because the total return from the stock has been mostly flat over the last year. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

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

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.

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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.