Returns On Capital Signal Tricky Times Ahead For NEXTDC (ASX:NXT)

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at NEXTDC (ASX:NXT) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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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. To calculate this metric for NEXTDC, this is the formula:

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

0.0028 = AU$14m ÷ (AU$5.2b - AU$139m) (Based on the trailing twelve months to December 2024).

Therefore, NEXTDC has an ROCE of 0.3%. In absolute terms, that's a low return and it also under-performs the IT industry average of 5.7%.

See our latest analysis for NEXTDC

Above you can see how the current ROCE for NEXTDC 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 NEXTDC for free.

What The Trend Of ROCE Can Tell Us

We weren't thrilled with the trend because NEXTDC's ROCE has reduced by 87% over the last five years, while the business employed 190% more capital. That being said, NEXTDC raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. NEXTDC probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

The Bottom Line On NEXTDC's ROCE

Bringing it all together, while we're somewhat encouraged by NEXTDC's reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 30% 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.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for NEXTDC (of which 2 can't be ignored!) that you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.