D4t4 Solutions (LON:D4T4) May Have Issues Allocating Its Capital
There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don't think D4t4 Solutions (LON:D4T4) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Understanding 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 D4t4 Solutions is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.026 = UK£805k ÷ (UK£45m - UK£14m) (Based on the trailing twelve months to September 2022).
Thus, D4t4 Solutions has an ROCE of 2.6%. In absolute terms, that's a low return and it also under-performs the IT industry average of 11%.
Check out our latest analysis for D4t4 Solutions
In the above chart we have measured D4t4 Solutions' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for D4t4 Solutions.
What The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at D4t4 Solutions doesn't inspire confidence. To be more specific, ROCE has fallen from 10% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.
On a side note, D4t4 Solutions' current liabilities have increased over the last five years to 32% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 2.6%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.
Our Take On D4t4 Solutions' ROCE
To conclude, we've found that D4t4 Solutions is reinvesting in the business, but returns have been falling. And investors may be recognizing these trends since the stock has only returned a total of 21% to shareholders over the last five years. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.
On a final note, we've found 3 warning signs for D4t4 Solutions that we think you should be aware of.
While D4t4 Solutions 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.
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