Investors Should Be Encouraged By Sonata Software's (NSE:SONATSOFTW) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. With that in mind, the ROCE of Sonata Software (NSE:SONATSOFTW) looks great, so lets see what the trend can tell us.

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. To calculate this metric for Sonata Software, this is the formula:

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

0.41 = ₹5.3b ÷ (₹29b - ₹16b) (Based on the trailing twelve months to December 2022).

So, Sonata Software has an ROCE of 41%. In absolute terms that's a great return and it's even better than the IT industry average of 12%.

See our latest analysis for Sonata Software

In the above chart we have measured Sonata Software's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Sonata Software.

What The Trend Of ROCE Can Tell Us

We like the trends that we're seeing from Sonata Software. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 41%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 103%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 55% of the business, which is more than it was five years ago. And with current liabilities at those levels, that's pretty high.

The Bottom Line

All in all, it's terrific to see that Sonata Software is reaping the rewards from prior investments and is growing its capital base. Since the stock has returned a staggering 215% to shareholders over the last five years, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if Sonata Software can keep these trends up, it could have a bright future ahead.

If you want to continue researching Sonata Software, you might be interested to know about the 2 warning signs that our analysis has discovered.

Sonata Software is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.