Hydsoft TechnologyLtd (SZSE:301316) Will Want To Turn Around Its Return Trends

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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 Hydsoft TechnologyLtd (SZSE:301316), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Hydsoft TechnologyLtd:

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

0.058 = CN¥71m ÷ (CN¥1.6b - CN¥349m) (Based on the trailing twelve months to June 2024).

Therefore, Hydsoft TechnologyLtd has an ROCE of 5.8%. In absolute terms, that's a low return, but it's much better than the IT industry average of 3.8%.

See 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 want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Hydsoft TechnologyLtd.

So How Is Hydsoft TechnologyLtd's ROCE Trending?

Unfortunately, the trend isn't great with ROCE falling from 17% five years ago, while capital employed has grown 520%. Usually this isn't ideal, but given Hydsoft TechnologyLtd conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. Hydsoft TechnologyLtd probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

On a related note, Hydsoft TechnologyLtd has decreased its current liabilities to 22% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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. And there could be an opportunity here if other metrics look good too, because the stock has declined 47% in the last year. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

On a final note, we found 3 warning signs for Hydsoft TechnologyLtd (1 makes us a bit uncomfortable) 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.