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To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think DGL Group (ASX:DGL) 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)?
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. The formula for this calculation on DGL Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.06 = AU$31m ÷ (AU$606m - AU$82m) (Based on the trailing twelve months to June 2024).
Therefore, DGL Group has an ROCE of 6.0%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 7.9%.
See our latest analysis for DGL Group
Above you can see how the current ROCE for DGL Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for DGL Group .
So How Is DGL Group's ROCE Trending?
On the surface, the trend of ROCE at DGL Group doesn't inspire confidence. Over the last five years, returns on capital have decreased to 6.0% from 7.8% five years ago. However it looks like DGL Group 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'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.
On a related note, DGL Group has decreased its current liabilities to 14% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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.
The Key Takeaway
Bringing it all together, while we're somewhat encouraged by DGL Group's reinvestment in its own business, we're aware that returns are shrinking. And investors may be expecting the fundamentals to get a lot worse because the stock has crashed 79% over the last three years. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.