- Oops!Something went wrong.Please try again later.
If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after glancing at the trends within NetSol Technologies (NASDAQ:NTWK), we weren't too hopeful.
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. To calculate this metric for NetSol Technologies, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.033 = US$1.9m ÷ (US$82m - US$24m) (Based on the trailing twelve months to March 2022).
So, NetSol Technologies has an ROCE of 3.3%. In absolute terms, that's a low return and it also under-performs the Software industry average of 10%.
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 want to delve into the historical earnings, revenue and cash flow of NetSol Technologies, check out these free graphs here.
The Trend Of ROCE
In terms of NetSol Technologies' historical ROCE trend, it isn't fantastic. The company used to generate 6.5% on its capital five years ago but it has since fallen noticeably. In addition to that, NetSol Technologies is now employing 28% less capital than it was five years ago. The fact that both are shrinking is an indication that the business is going through some tough times. If these underlying trends continue, we wouldn't be too optimistic going forward.
On a side note, NetSol Technologies' current liabilities have increased over the last five years to 29% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 3.3%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.
What We Can Learn From NetSol Technologies' ROCE
To see NetSol Technologies reducing the capital employed in the business in tandem with diminishing returns, is concerning. It should come as no surprise then that the stock has fallen 15% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
If you'd like to know about the risks facing NetSol Technologies, we've discovered 1 warning sign that you should be aware of.
While NetSol Technologies isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.