Sonata Software (NSE:SONATSOFTW) Is Reinvesting At Lower Rates Of Return

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Looking at Sonata Software (NSE:SONATSOFTW), it does have a high ROCE right now, but lets see how returns are trending.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Sonata Software is:

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

0.28 = ₹6.2b ÷ (₹48b - ₹26b) (Based on the trailing twelve months to December 2023).

Therefore, Sonata Software has an ROCE of 28%. That's a fantastic return and not only that, it outpaces the average of 20% earned by companies in a similar industry.

See our latest analysis for Sonata Software

Above you can see how the current ROCE for Sonata Software compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Sonata Software .

So How Is Sonata Software's ROCE Trending?

In terms of Sonata Software's historical ROCE movements, the trend isn't fantastic. While it's comforting that the ROCE is high, five years ago it was 43%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Sonata Software's current liabilities have increased over the last five years to 54% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Bottom Line

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Sonata Software. And long term investors must be optimistic going forward because the stock has returned a huge 608% to shareholders in the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.

On a final note, we've found 4 warning signs for Sonata Software that we think you should be aware of.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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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.