Demant (CPH:DEMANT) May Have Issues Allocating Its Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 Demant (CPH:DEMANT) and its ROCE trend, we weren't exactly thrilled.

What Is 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 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).

Therefore, Demant has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 8.4% generated by the Medical Equipment industry.

See 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 to see what analysts are forecasting going forward, you should check out our free analyst report for Demant .

What The Trend Of ROCE Can Tell Us

In terms of Demant's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 17% from 24% five years ago. 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.

On a related note, Demant has decreased its current liabilities to 22% of total assets. That could partly explain why the ROCE has dropped. 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line On Demant's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Demant. Furthermore the stock has climbed 54% over the last five years, it would appear that investors are upbeat about the future. So should these growth trends continue, we'd be optimistic on the stock going forward.

One more thing to note, we've identified 1 warning sign with Demant and understanding this should be part of your investment process.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.

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