Sonata Software (NSE:SONATSOFTW) Is Reinvesting To Multiply In Value

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So, when we ran our eye over Sonata Software's (NSE:SONATSOFTW) trend of ROCE, we really liked what we saw.

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. Analysts use this formula to calculate it for Sonata Software:

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

0.28 = ₹6.2b ÷ (₹44b - ₹22b) (Based on the trailing twelve months to March 2023).

Thus, Sonata Software has an ROCE of 28%. In absolute terms that's a great return and it's even better than the IT industry average of 14%.

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 report on analyst forecasts for the company.

SWOT Analysis for Sonata Software

How Are Returns Trending?

In terms of Sonata Software's history of ROCE, it's quite impressive. The company has employed 220% more capital in the last five years, and the returns on that capital have remained stable at 28%. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. You'll see this when looking at well operated businesses or favorable business models.

On a side note, Sonata Software's current liabilities are still rather high at 50% of total assets. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

Sonata Software has demonstrated its proficiency by generating high returns on increasing amounts of capital employed, which we're thrilled about. And the stock has done incredibly well with a 342% return over the last five years, so long term investors are no doubt ecstatic with that result. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

One final note, you should learn about the 4 warning signs we've spotted with Sonata Software (including 1 which is a bit concerning) .

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.