Chinasoft International (HKG:354) May Have Issues Allocating Its Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Chinasoft International (HKG:354), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Chinasoft International is:

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

0.062 = CN¥800m ÷ (CN¥17b - CN¥4.0b) (Based on the trailing twelve months to December 2021).

Therefore, Chinasoft International has an ROCE of 6.2%. In absolute terms, that's a low return but it's around the IT industry average of 7.1%.

Check out our latest analysis for Chinasoft International

Above you can see how the current ROCE for Chinasoft International compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Chinasoft International's ROCE Trend?

On the surface, the trend of ROCE at Chinasoft International doesn't inspire confidence. Around five years ago the returns on capital were 11%, but since then they've fallen to 6.2%. 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 related note, Chinasoft International has decreased its current liabilities to 24% of total assets. So we could link some of this to the decrease in ROCE. 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...

While returns have fallen for Chinasoft International in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. Furthermore the stock has climbed 89% over the last five years, it would appear that investors are upbeat about the future. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

One more thing, we've spotted 2 warning signs facing Chinasoft International that you might find interesting.

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.