SoftTech Engineers (NSE:SOFTTECH) May Have Issues Allocating Its Capital

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. However, after briefly looking over the numbers, we don't think SoftTech Engineers (NSE:SOFTTECH) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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

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 SoftTech Engineers is:

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

0.054 = ₹50m ÷ (₹1.2b - ₹265m) (Based on the trailing twelve months to September 2021).

Thus, SoftTech Engineers has an ROCE of 5.4%. In absolute terms, that's a low return and it also under-performs the Software industry average of 12%.

See our latest analysis for SoftTech Engineers

Historical performance is a great place to start when researching a stock so above you can see the gauge for SoftTech Engineers' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of SoftTech Engineers, check out these free graphs here.

The Trend Of ROCE

When we looked at the ROCE trend at SoftTech Engineers, we didn't gain much confidence. To be more specific, ROCE has fallen from 22% over the last five years. However it looks like SoftTech Engineers might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, SoftTech Engineers has done well to pay down its current liabilities to 22% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

To conclude, we've found that SoftTech Engineers is reinvesting in the business, but returns have been falling. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 135% gain to shareholders who have held over the last three years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

If you want to know some of the risks facing SoftTech Engineers we've found 5 warning signs (2 are potentially serious!) that you should be aware of before investing here.

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.