Investors Could Be Concerned With Megasoft's (NSE:MEGASOFT) Returns On Capital

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. And from a first read, things don't look too good at Megasoft (NSE:MEGASOFT), so let's see why.

What is 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. The formula for this calculation on Megasoft is:

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

0.00019 = ₹325k ÷ (₹3.3b - ₹1.7b) (Based on the trailing twelve months to December 2020).

Therefore, Megasoft has an ROCE of 0.02%. Ultimately, that's a low return and it under-performs the Software industry average of 12%.

Check out 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'd like to look at how Megasoft has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Megasoft's ROCE Trending?

In terms of Megasoft's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 1.0% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

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. Yet despite these concerning fundamentals, the stock has performed strongly with a 45% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you want to know some of the risks facing Megasoft we've found 3 warning signs (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

While Megasoft isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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