Return Trends At Downer EDI (ASX:DOW) Aren't Appealing
There are a few key trends to look for if we want to identify the next multi-bagger. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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 investigating Downer EDI (ASX:DOW), we don't think it's current trends fit the mold of a multi-bagger.
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. The formula for this calculation on Downer EDI is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.043 = AU$193m ÷ (AU$7.3b - AU$2.9b) (Based on the trailing twelve months to June 2023).
Therefore, Downer EDI has an ROCE of 4.3%. Ultimately, that's a low return and it under-performs the Commercial Services industry average of 7.8%.
See our latest analysis for Downer EDI
Above you can see how the current ROCE for Downer EDI compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Downer EDI.
What Does the ROCE Trend For Downer EDI Tell Us?
Things have been pretty stable at Downer EDI, with its capital employed and returns on that capital staying somewhat the same for the last five years. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. So unless we see a substantial change at Downer EDI in terms of ROCE and additional investments being made, we wouldn't hold our breath on it being a multi-bagger. That probably explains why Downer EDI has been paying out 64% of its earnings as dividends to shareholders. If the company is in fact lacking growth opportunities, that's one of the viable alternatives for the money.
The Bottom Line On Downer EDI's ROCE
In summary, Downer EDI isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Since the stock has declined 20% over the last five years, investors may not be too optimistic on this trend improving either. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.
One more thing to note, we've identified 1 warning sign with Downer EDI and understanding this should be part of your investment process.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.
