We're Watching These Trends At Direcional Engenharia (BVMF:DIRR3)

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. 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 Direcional Engenharia (BVMF:DIRR3), we don't think it's current trends fit the mold of a multi-bagger.

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

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. Analysts use this formula to calculate it for Direcional Engenharia:

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

0.044 = R$187m ÷ (R$4.8b - R$562m) (Based on the trailing twelve months to June 2020).

So, Direcional Engenharia has an ROCE of 4.4%. In absolute terms, that's a low return and it also under-performs the Consumer Durables industry average of 8.2%.

Check out our latest analysis for Direcional Engenharia

In the above chart we have measured Direcional Engenharia's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

So How Is Direcional Engenharia's ROCE Trending?

When we looked at the ROCE trend at Direcional Engenharia, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 4.4% from 6.9% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

What We Can Learn From Direcional Engenharia's ROCE

Bringing it all together, while we're somewhat encouraged by Direcional Engenharia's reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 389% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

Direcional Engenharia does have some risks, we noticed 2 warning signs (and 1 which makes us a bit uncomfortable) we think 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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