DigitalX (ASX:DCC) Might Have The Makings Of A Multi-Bagger

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. So on that note, DigitalX (ASX:DCC) looks quite promising in regards to its trends of return on capital.

Understanding 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. To calculate this metric for DigitalX, this is the formula:

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

0.11 = AU$5.8m ÷ (AU$55m - AU$3.6m) (Based on the trailing twelve months to June 2021).

Thus, DigitalX has an ROCE of 11%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Software industry average of 12%.

View our latest analysis for DigitalX

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating DigitalX's past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From DigitalX's ROCE Trend?

We're delighted to see that DigitalX is reaping rewards from its investments and is now generating some pre-tax profits. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 11% on its capital. And unsurprisingly, like most companies trying to break into the black, DigitalX is utilizing 2,183% more capital than it was five years ago. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

On a related note, the company's ratio of current liabilities to total assets has decreased to 6.6%, which basically reduces it's funding from the likes of short-term creditors or suppliers. So this improvement in ROCE has come from the business' underlying economics, which is great to see.

The Bottom Line On DigitalX's ROCE

To the delight of most shareholders, DigitalX has now broken into profitability. Since the stock has returned a staggering 113% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for DigitalX (of which 1 makes us a bit uncomfortable!) that you should know about.

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.