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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Megasoft (NSE:MEGASOFT) and its ROCE trend, we weren't exactly thrilled.
Understanding 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. To calculate this metric for Megasoft, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0014 = ₹2.7m ÷ (₹3.2b - ₹1.2b) (Based on the trailing twelve months to December 2021).
Thus, Megasoft has an ROCE of 0.1%. Ultimately, that's a low return and it under-performs the Software industry average of 15%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Megasoft's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Megasoft, check out these free graphs here.
The Trend Of ROCE
On the surface, the trend of ROCE at Megasoft doesn't inspire confidence. Over the last five years, returns on capital have decreased to 0.1% from 10.0% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.
Our Take On Megasoft's ROCE
In summary, Megasoft is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Yet to long term shareholders the stock has gifted them an incredible 194% return in the last five years, so the market appears to be rosy about its future. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
One more thing: We've identified 4 warning signs with Megasoft (at least 2 which shouldn't be ignored) , and understanding these would certainly be useful.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.