Demant (CPH:DEMANT) Is Reinvesting At Lower Rates Of Return

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. 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?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Demant:

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

0.088 = kr.1.3b ÷ (kr.22b - kr.7.4b) (Based on the trailing twelve months to December 2020).

Therefore, Demant has an ROCE of 8.8%. Even though it's in line with the industry average of 9.5%, it's still a low return by itself.

Check out 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 here for free.

What Does the ROCE Trend For Demant Tell Us?

When we looked at the ROCE trend at Demant, we didn't gain much confidence. Around five years ago the returns on capital were 20%, but since then they've fallen to 8.8%. 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

Our Take On Demant's ROCE

In summary, Demant is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Yet to long term shareholders the stock has gifted them an incredible 172% return in the last five years, so the market appears to be rosy about its future. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One more thing to note, we've identified 2 warning signs with Demant and understanding these should be part of your investment process.

While Demant 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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