Downer EDI (ASX:DOW) Has Some Way To Go To Become A Multi-Bagger

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Having said that, from a first glance at Downer EDI (ASX:DOW) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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 Downer EDI is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.069 = AU$283m ÷ (AU$6.7b - AU$2.7b) (Based on the trailing twelve months to June 2024).

So, Downer EDI has an ROCE of 6.9%. In absolute terms, that's a low return and it also under-performs the Commercial Services industry average of 11%.

View 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, you can check out the forecasts from the analysts covering Downer EDI for free.

What Does the ROCE Trend For Downer EDI Tell Us?

Over the past five years, Downer EDI's ROCE and capital employed have both remained mostly flat. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. So don't be surprised if Downer EDI doesn't end up being a multi-bagger in a few years time. That probably explains why Downer EDI has been paying out 62% of its earnings as dividends to shareholders. Most shareholders probably know this and own the stock for its dividend.

What We Can Learn From Downer EDI's ROCE

In a nutshell, Downer EDI has been trudging along with the same returns from the same amount of capital over the last five years. And investors appear hesitant that the trends will pick up because the stock has fallen 11% in the last five years. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

On a final note, we've found 2 warning signs for Downer EDI that we think 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.

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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.