The Returns At Tera Software (NSE:TERASOFT) Provide Us With Signs Of What's To Come

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Tera Software (NSE:TERASOFT) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding 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. The formula for this calculation on Tera Software is:

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

0.087 = ₹97m ÷ (₹2.9b - ₹1.8b) (Based on the trailing twelve months to December 2020).

Thus, Tera Software has an ROCE of 8.7%. In absolute terms, that's a low return but it's around the IT industry average of 11%.

See our latest analysis for Tera Software

Historical performance is a great place to start when researching a stock so above you can see the gauge for Tera Software's ROCE against it's prior returns. If you'd like to look at how Tera Software has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Tera Software Tell Us?

On the surface, the trend of ROCE at Tera Software doesn't inspire confidence. Around five years ago the returns on capital were 25%, but since then they've fallen to 8.7%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Tera Software's current liabilities have increased over the last five years to 62% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 8.7%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

In Conclusion...

We're a bit apprehensive about Tera Software because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Investors haven't taken kindly to these developments, since the stock has declined 30% from where it was three years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing: We've identified 5 warning signs with Tera Software (at least 3 which are potentially serious) , and understanding them would certainly be useful.

While Tera Software isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. 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.
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