Does Megasoft's (NSE:MEGASOFT) Returns On Capital Reflect Well On The Business?

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. On that note, looking into Megasoft (NSE:MEGASOFT), we weren't too upbeat about how things were going.

What is 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. To calculate this metric for Megasoft, this is the formula:

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

0.0059 = ₹9.6m ÷ (₹3.3b - ₹1.7b) (Based on the trailing twelve months to September 2020).

Therefore, Megasoft has an ROCE of 0.6%. In absolute terms, that's a low return and it also under-performs the Software industry average of 12%.

View our latest analysis for Megasoft

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 Megasoft's past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Megasoft Tell Us?

We are a bit worried about the trend of returns on capital at Megasoft. To be more specific, the ROCE was 1.9% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Megasoft becoming one if things continue as they have.

On a separate but related note, it's important to know that Megasoft has a current liabilities to total assets ratio of 51%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On Megasoft's ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. And long term shareholders have watched their investments stay flat over the last five years. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

On a final note, we've found 1 warning sign for Megasoft that we think you should be aware of.

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