To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. On that note, looking into Dierig Holding (ETR:DIE), we weren't too upbeat about how things were going.
Understanding 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. Analysts use this formula to calculate it for Dierig Holding:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.055 = €4.8m ÷ (€118m - €30m) (Based on the trailing twelve months to June 2020).
Thus, Dierig Holding has an ROCE of 5.5%. Even though it's in line with the industry average of 5.5%, it's still a low return by itself.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Dierig Holding's ROCE against it's prior returns. If you'd like to look at how Dierig Holding has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Dierig Holding Tell Us?
There is reason to be cautious about Dierig Holding, given the returns are trending downwards. About five years ago, returns on capital were 7.6%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Dierig Holding to turn into a multi-bagger.
What We Can Learn From Dierig Holding's ROCE
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Yet despite these concerning fundamentals, the stock has performed strongly with a 41% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
On a final note, we found 6 warning signs for Dierig Holding (1 is a bit unpleasant) 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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