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What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Danaos (NYSE:DAC), it didn't seem to tick all of these boxes.
What is 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. Analysts use this formula to calculate it for Danaos:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.079 = US$195m ÷ (US$2.7b - US$239m) (Based on the trailing twelve months to June 2020).
Thus, Danaos has an ROCE of 7.9%. On its own, that's a low figure but it's around the 6.8% average generated by the Shipping industry.
In the above chart we have measured Danaos' 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 Danaos here for free.
What Can We Tell From Danaos' ROCE Trend?
We're a bit concerned with the trends, because the business is applying 29% less capital than it was five years ago and returns on that capital have stayed flat. To us that doesn't look like a multi-bagger because the company appears to be selling assets and it's returns aren't increasing. Not only that, but the low returns on this capital mentioned earlier would leave most investors unimpressed.
The Key Takeaway
It's a shame to see that Danaos is effectively shrinking in terms of its capital base. Moreover, since the stock has crumbled 90% over the last five years, it appears investors are expecting the worst. Therefore based on the analysis done in this article, we don't think Danaos has the makings of a multi-bagger.
If you'd like to know more about Danaos, we've spotted 3 warning signs, and 1 of them is potentially serious.
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.
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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