Capital Allocation Trends At Demant (CPH:DEMANT) Aren't Ideal

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Demant (CPH:DEMANT) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Return On Capital Employed (ROCE): What Is It?

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 Demant, this is the formula:

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

0.17 = kr.4.1b ÷ (kr.31b - kr.6.9b) (Based on the trailing twelve months to December 2023).

Thus, Demant has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 8.6% generated by the Medical Equipment industry.

View our latest analysis for Demant

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

The Trend Of ROCE

When we looked at the ROCE trend at Demant, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 17% from 24% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Demant has decreased its current liabilities to 22% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Key Takeaway

In summary, despite lower returns in the short term, we're encouraged to see that Demant is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 76% over the last five years, it would appear that investors are upbeat about the future. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

Demant does have some risks though, and we've spotted 1 warning sign for Demant that you might be interested in.

While Demant may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.