Should You Be Impressed By Software Service's (TYO:3733) Returns on Capital?

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Software Service (TYO:3733) and its ROCE trend, we weren't exactly thrilled.

Understanding 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 Software Service:

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

0.14 = JP¥3.4b ÷ (JP¥27b - JP¥4.1b) (Based on the trailing twelve months to October 2020).

So, Software Service has an ROCE of 14%. That's a relatively normal return on capital, and it's around the 13% generated by the Healthcare Services industry.

See our latest analysis for Software Service

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

What The Trend Of ROCE Can Tell Us

In terms of Software Service's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 20% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

The Bottom Line

To conclude, we've found that Software Service is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 173% return in the last five years, so the market appears to be rosy about its future. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

On a final note, we've found 1 warning sign for Software Service that we think you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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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