Investors Could Be Concerned With Tera Software's (NSE:TERASOFT) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Tera Software (NSE:TERASOFT), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What is it?

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 Tera Software:

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

0.095 = ₹107m ÷ (₹3.0b - ₹1.9b) (Based on the trailing twelve months to December 2021).

Therefore, Tera Software has an ROCE of 9.5%. On its own, that's a low figure but it's around the 12% average generated by the IT industry.

View our latest analysis for Tera Software

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Tera Software's past further, check out this free graph of past earnings, revenue and cash flow.

So How Is Tera Software's ROCE Trending?

When we looked at the ROCE trend at Tera Software, we didn't gain much confidence. Around five years ago the returns on capital were 26%, but since then they've fallen to 9.5%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

Another thing to note, Tera Software has a high ratio of current liabilities to total assets of 62%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

Our Take On Tera Software's ROCE

In summary, we're somewhat concerned by Tera Software's diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last five years have experienced a 53% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Tera Software does have some risks, we noticed 5 warning signs (and 3 which can't be ignored) we think you should know about.

While Tera Software may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list 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.