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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. That's why when we briefly looked at Dicker Data's (ASX:DDR) ROCE trend, we were very happy with what we saw.
What is Return On Capital Employed (ROCE)?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Dicker Data is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.47 = AU$78m ÷ (AU$578m - AU$411m) (Based on the trailing twelve months to June 2020).
So, Dicker Data has an ROCE of 47%. That's a fantastic return and not only that, it outpaces the average of 16% earned by companies in a similar industry.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Dicker Data, check out these free graphs here.
So How Is Dicker Data's ROCE Trending?
Dicker Data deserves to be commended in regards to it's returns. Over the past five years, ROCE has remained relatively flat at around 47% and the business has deployed 124% more capital into its operations. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. You'll see this when looking at well operated businesses or favorable business models.
Another thing to note, Dicker Data has a high ratio of current liabilities to total assets of 71%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
In summary, we're delighted to see that Dicker Data has been compounding returns by reinvesting at consistently high rates of return, as these are common traits of a multi-bagger. And long term investors would be thrilled with the 517% return they've received over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.
On a final note, we found 4 warning signs for Dicker Data (1 makes us a bit uncomfortable) you should be aware of.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
This article by Simply Wall St is general in nature. 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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