Dignity (LON:DTY) Could Be Struggling To Allocate Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. However, after briefly looking over the numbers, we don't think Dignity (LON:DTY) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. Analysts use this formula to calculate it for Dignity:

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

0.024 = UK£42m ÷ (UK£1.9b - UK£196m) (Based on the trailing twelve months to June 2021).

So, Dignity has an ROCE of 2.4%. In absolute terms, that's a low return and it also under-performs the Consumer Services industry average of 20%.

View our latest analysis for Dignity

In the above chart we have measured Dignity'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 Dignity.

What Does the ROCE Trend For Dignity Tell Us?

On the surface, the trend of ROCE at Dignity doesn't inspire confidence. To be more specific, ROCE has fallen from 15% over the last five years. However it looks like Dignity might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

Our Take On Dignity's ROCE

In summary, Dignity is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. It seems that investors have little hope of these trends getting any better and that may have partly contributed to the stock collapsing 74% 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 final note, you should learn about the 4 warning signs we've spotted with Dignity (including 2 which are a bit concerning) .

While Dignity isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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.

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