The Returns At Dignity (LON:DTY) Provide Us With Signs Of What's To Come

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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. However, after investigating Dignity (LON:DTY), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Dignity, this is the formula:

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

0.031 = UK£53m ÷ (UK£1.9b - UK£185m) (Based on the trailing twelve months to June 2020).

So, Dignity has an ROCE of 3.1%. In absolute terms, that's a low return and it also under-performs the Consumer Services industry average of 12%.

See 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, you can check out the forecasts from the analysts covering Dignity here for free.

What Can We Tell From Dignity's ROCE Trend?

When we looked at the ROCE trend at Dignity, we didn't gain much confidence. To be more specific, ROCE has fallen from 17% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. 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.

The Bottom Line On Dignity's ROCE

To conclude, we've found that Dignity is reinvesting in the business, but returns have been falling. It seems that investors have little hope of these trends getting any better and that may have partly contributed to the stock collapsing 76% 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.

Dignity does have some risks, we noticed 3 warning signs (and 2 which shouldn't be ignored) we think you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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This article by Simply Wall St is general in nature. 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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