The Returns At Dialight (LON:DIA) Aren't Growing

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 briefly looking over the numbers, we don't think Dialight (LON:DIA) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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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 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

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 analyst report for Dialight .

What The Trend Of ROCE Can Tell Us

We've noticed that although returns on capital are flat over the last five years, the amount of capital employed in the business has fallen 35% in that same period. To us that doesn't look like a multi-bagger because the company appears to be selling assets and it's returns aren't increasing. In addition to that, since the ROCE doesn't scream "quality" at 3.6%, it's hard to get excited about these developments.

On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up 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. So with current liabilities at such high levels, this effectively means the likes of suppliers or short-term creditors are funding a meaningful part of the business, which in some instances can bring some risks.

The Key Takeaway

It's a shame to see that Dialight is effectively shrinking in terms of its capital base. And investors appear hesitant that the trends will pick up because the stock has fallen 59% in the last five years. 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.

One more thing, we've spotted 1 warning sign facing Dialight that you might find interesting.

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.