There Are Reasons To Feel Uneasy About Dignity's (LON:DTY) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Dignity (LON:DTY), it didn't seem to tick all of these boxes.

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 Dignity, this is the formula:

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

0.021 = UK£33m ÷ (UK£1.7b - UK£171m) (Based on the trailing twelve months to July 2022).

So, Dignity has an ROCE of 2.1%. In absolute terms, that's a low return and it also under-performs the Consumer Services industry average of 12%.

Check out the opportunities and risks within the GB Consumer Services industry.

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. Over the last five years, returns on capital have decreased to 2.1% from 16% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Dignity's reinvestment in its own business, we're aware that returns are shrinking. It seems that investors have little hope of these trends getting any better and that may have partly contributed to the stock collapsing 80% in the last five years. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

If you'd like to know more about Dignity, we've spotted 4 warning signs, and 3 of them are significant.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.