Dialight (LON:DIA) Could Be At Risk Of Shrinking As A Company

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. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. So after we looked into Dialight (LON:DIA), the trends above didn't look too great.

What is 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 Dialight, this is the formula:

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

0.021 = UK£1.8m ÷ (UK£126m - UK£40m) (Based on the trailing twelve months to December 2021).

Thus, Dialight has an ROCE of 2.1%. Ultimately, that's a low return and it under-performs the Electrical industry average of 13%.

Check out our latest analysis for Dialight

In the above chart we have measured Dialight's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

So How Is Dialight's ROCE Trending?

We are a bit worried about the trend of returns on capital at Dialight. About five years ago, returns on capital were 16%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Dialight becoming one if things continue as they have.

The Bottom Line

In summary, it's unfortunate that Dialight is generating lower returns from the same amount of capital. Long term shareholders who've owned the stock over the last five years have experienced a 70% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing to note, we've identified 1 warning sign with Dialight and understanding it 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.