Investors Will Want DigitalX's (ASX:DCC) Growth In ROCE To Persist

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. 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)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for DigitalX:

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

0.085 = AU$6.1m ÷ (AU$73m - AU$1.1m) (Based on the trailing twelve months to December 2021).

Therefore, DigitalX has an ROCE of 8.5%. In absolute terms, that's a low return and it also under-performs the Software industry average of 13%.

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 want to delve into the historical earnings, revenue and cash flow of DigitalX, check out these free graphs here.

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. The company was generating losses five years ago, but now it's earning 8.5% which is a sight for sore eyes. In addition to that, DigitalX is employing 4,107% more capital than previously which is expected of a company that's trying to break into profitability. 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.

In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 1.5%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.

What We Can Learn From DigitalX's ROCE

In summary, it's great to see that DigitalX has managed to break into profitability and is continuing to reinvest in its business. Since the stock has only returned 35% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. So with that in mind, we think the stock deserves further research.

One final note, you should learn about the 3 warning signs we've spotted with DigitalX (including 1 which is a bit unpleasant) .

While DigitalX isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.