discoverIE Group's (LON:DSCV) Returns Have Hit A Wall

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating discoverIE Group (LON:DSCV), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on discoverIE Group is:

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

0.058 = UK£27m ÷ (UK£573m - UK£105m) (Based on the trailing twelve months to September 2021).

Thus, discoverIE Group has an ROCE of 5.8%. Ultimately, that's a low return and it under-performs the Electrical industry average of 13%.

See our latest analysis for discoverIE Group

In the above chart we have measured discoverIE Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for discoverIE Group.

How Are Returns Trending?

The returns on capital haven't changed much for discoverIE Group in recent years. The company has consistently earned 5.8% for the last five years, and the capital employed within the business has risen 151% in that time. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.

The Key Takeaway

In summary, discoverIE Group has simply been reinvesting capital and generating the same low rate of return as before. Yet to long term shareholders the stock has gifted them an incredible 183% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

One more thing, we've spotted 3 warning signs facing discoverIE Group that you might find interesting.

While discoverIE Group may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.