Dialight (LON:DIA) Will Be Hoping To Turn Its Returns On Capital Around

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Although, when we looked at Dialight (LON:DIA), it didn't seem to tick all of these boxes.

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

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

0.031 = UK£3.1m ÷ (UK£144m - UK£43m) (Based on the trailing twelve months to December 2022).

Thus, Dialight has an ROCE of 3.1%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 13%.

View 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?

On the surface, the trend of ROCE at Dialight doesn't inspire confidence. To be more specific, ROCE has fallen from 12% over the last five years. 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.

The Bottom Line On Dialight's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Dialight is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 58% over the last five years, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Like most companies, Dialight does come with some risks, and we've found 3 warning signs that you should be aware of.

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.