Returns On Capital At Downer EDI (ASX:DOW) Paint A Concerning Picture

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. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Downer EDI (ASX:DOW), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What is it?

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. Analysts use this formula to calculate it for Downer EDI:

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

0.044 = AU$203m ÷ (AU$7.3b - AU$2.7b) (Based on the trailing twelve months to December 2021).

Thus, Downer EDI has an ROCE of 4.4%. Ultimately, that's a low return and it under-performs the Commercial Services industry average of 6.0%.

Check out 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.

So How Is Downer EDI's ROCE Trending?

When we looked at the ROCE trend at Downer EDI, we didn't gain much confidence. To be more specific, ROCE has fallen from 10.0% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

What We Can Learn From Downer EDI's ROCE

Bringing it all together, while we're somewhat encouraged by Downer EDI's reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 8.2% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

On a separate note, we've found 2 warning signs for Downer EDI you'll probably want to know about.

While Downer EDI 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.