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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'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Dianomi (LON:DNM), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What Is It?
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 Dianomi is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.018 = UK£157k ÷ (UK£15m - UK£5.9m) (Based on the trailing twelve months to June 2024).
Therefore, Dianomi has an ROCE of 1.8%. In absolute terms, that's a low return and it also under-performs the Media industry average of 10%.
See our latest analysis for Dianomi
In the above chart we have measured Dianomi's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Dianomi for free.
How Are Returns Trending?
In terms of Dianomi's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 1.8% from 3.7% five years ago. However it looks like Dianomi 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, Dianomi has decreased its current liabilities to 40% 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. Keep in mind 40% is still pretty high, so those risks are still somewhat prevalent.
What We Can Learn From Dianomi's ROCE
Bringing it all together, while we're somewhat encouraged by Dianomi'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 89% 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.