Returns Are Gaining Momentum At DigitalX (ASX:DCC)

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Speaking of which, we noticed some great changes in DigitalX's (ASX:DCC) returns on capital, so let's have a look.

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 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%.

See our latest analysis for DigitalX

Historical performance is a great place to start when researching a stock so above you can see the gauge for DigitalX's ROCE against it's prior returns. If you're interested in investigating DigitalX's past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For DigitalX Tell Us?

We're delighted to see that DigitalX is reaping rewards from its investments and is now generating some pre-tax profits. About five years ago the company was generating losses but things have turned around because it's now earning 8.5% on its capital. Not only that, but the company is utilizing 4,107% more capital than before, but that's to be expected from a company trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

One more thing to note, DigitalX has decreased current liabilities to 1.5% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. So this improvement in ROCE has come from the business' underlying economics, which is great to see.

Our Take On DigitalX's ROCE

To the delight of most shareholders, DigitalX has now broken into profitability. And with a respectable 83% awarded to those who held the stock over the last five years, you could argue that these developments are starting to get the attention they deserve. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

On a final note, we found 3 warning signs for DigitalX (1 is a bit concerning) 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.