Should We Be Excited About The Trends Of Returns At Chinasoft International (HKG:354)?

There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Chinasoft International (HKG:354) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What is it?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Chinasoft International, this is the formula:

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

0.086 = CN¥838m ÷ (CN¥12b - CN¥2.0b) (Based on the trailing twelve months to June 2020).

Therefore, Chinasoft International has an ROCE of 8.6%. On its own that's a low return on capital but it's in line with the industry's average returns of 8.6%.

Check out our latest analysis for Chinasoft International

In the above chart we have measured Chinasoft International's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Chinasoft International here for free.

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

The returns on capital haven't changed much for Chinasoft International in recent years. Over the past five years, ROCE has remained relatively flat at around 8.6% and the business has deployed 168% more capital into its operations. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.

On a side note, Chinasoft International has done well to reduce current liabilities to 17% of total assets over the last five years. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.

What We Can Learn From Chinasoft International's ROCE

In summary, Chinasoft International has simply been reinvesting capital and generating the same low rate of return as before. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 285% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One more thing to note, we've identified 3 warning signs with Chinasoft International and understanding them should be part of your investment process.

While Chinasoft International 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.

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