dotdigital Group (LON:DOTD) Could Be Struggling To Allocate Capital
If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. However, after briefly looking over the numbers, we don't think dotdigital Group (LON:DOTD) 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)
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. The formula for this calculation on dotdigital Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = UK£14m ÷ (UK£100m - UK£16m) (Based on the trailing twelve months to June 2023).
Thus, dotdigital Group has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 9.3% generated by the Software industry.
View our latest analysis for dotdigital Group
Above you can see how the current ROCE for dotdigital Group 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 dotdigital Group here for free.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at dotdigital Group, we didn't gain much confidence. To be more specific, ROCE has fallen from 23% over the last five years. 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
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for dotdigital Group. In light of this, the stock has only gained 22% over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.
On a final note, we've found 1 warning sign for dotdigital Group that we think you should be aware of.
While dotdigital Group 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.
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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.
