Sonata Software (NSE:SONATSOFTW) Might Be Having Difficulty Using Its Capital Effectively

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Looking at Sonata Software (NSE:SONATSOFTW), it does have a high ROCE right now, but lets see how returns are trending.

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What Is Return On Capital Employed (ROCE)?

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

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

0.23 = ₹5.6b ÷ (₹46b - ₹21b) (Based on the trailing twelve months to September 2025).

Thus, Sonata Software has an ROCE of 23%. In absolute terms that's a great return and it's even better than the IT industry average of 17%.

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'd like, you can check out the forecasts from the analysts covering Sonata Software for free.

How Are Returns Trending?

On the surface, the trend of ROCE at Sonata Software doesn't inspire confidence. To be more specific, while the ROCE is still high, it's fallen from 38% where it was five years ago. 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 separate but related note, it's important to know that Sonata Software has a current liabilities to total assets ratio of 46%, which we'd consider pretty high. 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 Bottom Line On Sonata Software's ROCE

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 173% to shareholders in the last five years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

Sonata Software does have some risks though, and we've spotted 1 warning sign for Sonata Software that you might be interested in.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning 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.