What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. That's why when we briefly looked at DLH Holdings' (NASDAQ:DLHC) ROCE trend, we were pretty happy with what we saw.
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 DLH Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = US$14m ÷ (US$151m - US$36m) (Based on the trailing twelve months to June 2020).
So, DLH Holdings has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Professional Services industry average of 9.9% it's much better.
In the above chart we have measured DLH Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for DLH Holdings.
So How Is DLH Holdings' ROCE Trending?
While the current returns on capital are decent, they haven't changed much. The company has employed 685% more capital in the last five years, and the returns on that capital have remained stable at 12%. 12% is a pretty standard return, and it provides some comfort knowing that DLH Holdings has consistently earned this amount. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.
Our Take On DLH Holdings' ROCE
The main thing to remember is that DLH Holdings has proven its ability to continually reinvest at respectable rates of return. And long term investors would be thrilled with the 175% return they've received over the last five years. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.
If you'd like to know about the risks facing DLH Holdings, we've discovered 4 warning signs that you should be aware of.
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.
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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