Returns On Capital Signal Tricky Times Ahead For Powersoft (BIT:PWS)

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Powersoft (BIT:PWS) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from 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)

0.085 = €2.0m ÷ (€31m - €7.4m) (Based on the trailing twelve months to December 2020).

Thus, Powersoft has an ROCE of 8.5%. 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

In the above chart we have measured Powersoft's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For Powersoft Tell Us?

When we looked at the ROCE trend at Powersoft, we didn't gain much confidence. Around four years ago the returns on capital were 21%, but since then they've fallen to 8.5%. And considering revenue has dropped while employing more capital, we'd be cautious. 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.

On a side note, Powersoft has done well to pay down its current liabilities to 24% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

Our Take On Powersoft's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Powersoft have fallen, meanwhile the business is employing more capital than it was four years ago. Yet despite these concerning fundamentals, the stock has performed strongly with a 50% return over the last year, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Powersoft does have some risks, we noticed 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

While Powersoft 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. 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.
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