Returns On Capital Signal Tricky Times Ahead For LSI Software (WSE:LSI)

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. However, after briefly looking over the numbers, we don't think LSI Software (WSE:LSI) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for LSI Software, this is the formula:

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

0.085 = zł4.5m ÷ (zł61m - zł8.5m) (Based on the trailing twelve months to September 2023).

So, LSI Software has an ROCE of 8.5%. In absolute terms, that's a low return and it also under-performs the Software industry average of 15%.

Check out our latest analysis for LSI 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 LSI Software's past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From LSI Software's ROCE Trend?

When we looked at the ROCE trend at LSI Software, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 8.5% from 19% five years ago. However it looks like LSI Software might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

The Bottom Line On LSI Software's ROCE

Bringing it all together, while we're somewhat encouraged by LSI Software's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 48% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

On a final note, we found 2 warning signs for LSI Software (1 is potentially serious) 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. 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.