Slowing Rates Of Return At Dialight (LON:DIA) Leave Little Room For Excitement

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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Dialight (LON:DIA), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What Is It?

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 Dialight, this is the formula:

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

0.036 = US$2.8m ÷ (US$133m - US$56m) (Based on the trailing twelve months to September 2024).

So, Dialight has an ROCE of 3.6%. Ultimately, that's a low return and it under-performs the Electrical industry average of 13%.

See our latest analysis for Dialight

Above you can see how the current ROCE for Dialight 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 Dialight .

The Trend Of ROCE

Over the past five years, Dialight's ROCE has remained relatively flat while the business is using 35% less capital than before. When a company effectively decreases its assets base, it's not usually a sign to be optimistic on that company. In addition to that, since the ROCE doesn't scream "quality" at 3.6%, it's hard to get excited about these developments.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 42% of total assets, this reported ROCE would probably be less than3.6% because total capital employed would be higher.The 3.6% ROCE could be even lower if current liabilities weren't 42% of total assets, because the the formula would show a larger base of total capital employed. Additionally, this high level of current liabilities isn't ideal because it means the company's suppliers (or short-term creditors) are effectively funding a large portion of the business.

The Bottom Line

It's a shame to see that Dialight is effectively shrinking in terms of its capital base. And in the last five years, the stock has given away 58% so the market doesn't look too hopeful on these trends strengthening any time soon. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

On a final note, we've found 2 warning signs for Dialight that we think you should be aware of.

While Dialight 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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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.