Dialight (LON:DIA) Is Reinvesting At Lower Rates Of Return
To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Dialight (LON:DIA) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What Is It?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Dialight, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.039 = UK£3.9m ÷ (UK£144m - UK£43m) (Based on the trailing twelve months to December 2022).
So, Dialight has an ROCE of 3.9%. Ultimately, that's a low return and it under-performs the Electrical industry average of 12%.
Check out our latest analysis for Dialight
In the above chart we have measured Dialight'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 Dialight here for free.
So How Is Dialight's ROCE Trending?
On the surface, the trend of ROCE at Dialight doesn't inspire confidence. Around five years ago the returns on capital were 12%, but since then they've fallen to 3.9%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
The Bottom Line On Dialight's ROCE
While returns have fallen for Dialight in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And there could be an opportunity here if other metrics look good too, because the stock has declined 59% in the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.
If you want to continue researching Dialight, you might be interested to know about the 2 warning signs that our analysis has discovered.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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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.
