Some Investors May Be Worried About Hydsoft TechnologyLtd's (SZSE:301316) Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. In light of that, when we looked at Hydsoft TechnologyLtd (SZSE:301316) and its ROCE trend, we weren't exactly thrilled.

What Is 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. To calculate this metric for Hydsoft TechnologyLtd, this is the formula:

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

0.067 = CN¥83m ÷ (CN¥1.5b - CN¥293m) (Based on the trailing twelve months to March 2024).

Thus, Hydsoft TechnologyLtd has an ROCE of 6.7%. On its own that's a low return, but compared to the average of 4.0% 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.

What The Trend Of ROCE Can Tell Us

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 647% more capital. 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. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Hydsoft TechnologyLtd's earnings and if they change as a result from the capital raise. Also, we found that by looking at the company's latest EBIT, the figure is within 10% of the previous year's EBIT so you can basically assign the ROCE drop primarily to that capital raise.

On a related note, Hydsoft TechnologyLtd has decreased its current liabilities to 19% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Hydsoft TechnologyLtd'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 Hydsoft TechnologyLtd. And there could be an opportunity here if other metrics look good too, because the stock has declined 31% in 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.

While Hydsoft TechnologyLtd 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.

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.