DNXCorp (EPA:ALDNX) Has Some Difficulty Using Its Capital Effectively

When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. So after glancing at the trends within DNXCorp (EPA:ALDNX), we weren't too hopeful.

Understanding Return On Capital Employed (ROCE)

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. To calculate this metric for DNXCorp, this is the formula:

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

0.33 = €4.3m ÷ (€20m - €6.6m) (Based on the trailing twelve months to June 2022).

So, DNXCorp has an ROCE of 33%. In absolute terms that's a great return and it's even better than the Interactive Media and Services industry average of 15%.

Check out our latest analysis for DNXCorp

Historical performance is a great place to start when researching a stock so above you can see the gauge for DNXCorp's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of DNXCorp, check out these free graphs here.

So How Is DNXCorp's ROCE Trending?

In terms of DNXCorp's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 44%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on DNXCorp becoming one if things continue as they have.

On a side note, DNXCorp has done well to pay down its current liabilities to 34% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Yet despite these poor fundamentals, the stock has gained a huge 294% 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 separate note, we've found 3 warning signs for DNXCorp you'll probably want to know about.

High returns are a key ingredient to strong performance, so check out our free list ofstocks 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.