Powersoft (BIT:PWS) May Have Issues Allocating Its Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. 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. Having said that, from a first glance at Powersoft (BIT:PWS) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. The formula for this calculation on Powersoft is:

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

0.09 = €2.5m ÷ (€35m - €7.5m) (Based on the trailing twelve months to December 2021).

Therefore, Powersoft has an ROCE of 9.0%. In absolute terms, that's a low return and it also under-performs the Consumer Durables industry average of 12%.

See our latest analysis for Powersoft

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

What Can We Tell From Powersoft's ROCE Trend?

When we looked at the ROCE trend at Powersoft, we didn't gain much confidence. To be more specific, ROCE has fallen from 21% over the last five years. 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. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Powersoft has decreased its current liabilities to 21% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that Powersoft is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 12% over the last three years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Powersoft (of which 1 is concerning!) that you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and 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.