Why You Should Care About Sonata Software's (NSE:SONATSOFTW) Strong Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. 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)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed 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)

0.32 = ₹6.3b ÷ (₹48b - ₹28b) (Based on the trailing twelve months to September 2024).

So, Sonata Software has an ROCE of 32%. 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

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

So How Is Sonata Software's ROCE Trending?

In terms of Sonata Software's history of ROCE, it's quite impressive. The company has consistently earned 32% for the last five years, and the capital employed within the business has risen 110% in that time. 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.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 59% of total assets, this reported ROCE would probably be less than32% because total capital employed would be higher.The 32% ROCE could be even lower if current liabilities weren't 59% of total assets, because the the formula would show a larger base of total capital employed. So with current liabilities at such high levels, this effectively means the likes of suppliers or short-term creditors are funding a meaningful part of the business, which in some instances can bring some risks.

What We Can Learn From Sonata Software's ROCE

In short, we'd argue Sonata Software has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. And the stock has done incredibly well with a 557% return over the last five years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.

Sonata Software does have some risks though, and we've spotted 4 warning signs for Sonata Software that you might be interested in.

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.