Capital Allocation Trends At Danaos (NYSE:DAC) Aren't Ideal
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. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Danaos (NYSE:DAC) and its ROCE trend, we weren't exactly thrilled.
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. Analysts use this formula to calculate it for Danaos:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.19 = US$621m ÷ (US$3.5b - US$253m) (Based on the trailing twelve months to March 2023).
Therefore, Danaos has an ROCE of 19%. On its own, that's a standard return, however it's much better than the 15% generated by the Shipping industry.
View our latest analysis for Danaos
Above you can see how the current ROCE for Danaos compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Danaos here for free.
So How Is Danaos' ROCE Trending?
When we looked at the ROCE trend at Danaos, we didn't gain much confidence. To be more specific, ROCE has fallen from 31% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
On a side note, Danaos has done well to pay down its current liabilities to 7.3% of total assets. Considering it used to be 79%, that's a huge drop in that ratio and it would explain the decline in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.
What We Can Learn From Danaos' ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Danaos is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 117% return over the last five years, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we'd be optimistic on the stock going forward.
Like most companies, Danaos does come with some risks, and we've found 3 warning signs that you should be aware of.
While Danaos may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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.
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