Diagnósticos da América (BVMF:DASA3) May Have Issues Allocating Its Capital

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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Diagnósticos da América (BVMF:DASA3) and its ROCE trend, we weren't exactly thrilled.

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 Diagnósticos da América, this is the formula:

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

0.0051 = R$84m ÷ (R$23b - R$6.9b) (Based on the trailing twelve months to December 2021).

Thus, Diagnósticos da América has an ROCE of 0.5%. Ultimately, that's a low return and it under-performs the Healthcare industry average of 7.6%.

View our latest analysis for Diagnósticos da América

In the above chart we have measured Diagnósticos da América's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Diagnósticos da América here for free.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Diagnósticos da América, we didn't gain much confidence. To be more specific, ROCE has fallen from 7.2% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 30%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 0.5%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

The Bottom Line

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Diagnósticos da América. However, despite the promising trends, the stock has fallen 21% over the last five years, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Diagnósticos da América does have some risks, we noticed 4 warning signs (and 1 which is potentially serious) we think you should know about.

While Diagnósticos da América 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.