Here's What To Make Of discoverIE Group's (LON:DSCV) Decelerating Rates Of Return

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. In light of that, when we looked at discoverIE Group (LON:DSCV) and its ROCE trend, we weren't exactly thrilled.

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. 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).

So, discoverIE Group has an ROCE of 5.8%. Ultimately, that's a low return and it under-performs the Electrical industry average of 14%.

Check out 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, you can check out the forecasts from the analysts covering discoverIE Group here for free.

What The Trend Of ROCE Can Tell Us

The returns on capital haven't changed much for discoverIE Group in recent years. The company has employed 151% more capital in the last five years, and the returns on that capital have remained stable at 5.8%. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.

The Key Takeaway

In summary, discoverIE Group has simply been reinvesting capital and generating the same low rate of return as before. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 381% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

On a separate note, we've found 2 warning signs for discoverIE Group you'll probably want to know about.

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.