If you're looking for a multi-bagger, there's a few things to keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think DS Smith (LON:SMDS) 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)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for DS Smith, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.086 = UK£596m ÷ (UK£10b - UK£3.5b) (Based on the trailing twelve months to October 2022).
Therefore, DS Smith has an ROCE of 8.6%. In absolute terms, that's a low return but it's around the Packaging industry average of 10%.
See our latest analysis for DS Smith
In the above chart we have measured DS Smith's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What The Trend Of ROCE Can Tell Us
The returns on capital haven't changed much for DS Smith in recent years. The company has consistently earned 8.6% for the last five years, and the capital employed within the business has risen 58% 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, DS Smith has simply been reinvesting capital and generating the same low rate of return as before. And in the last five years, the stock has given away 20% so the market doesn't look too hopeful on these trends strengthening any time soon. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.
One more thing to note, we've identified 1 warning sign with DS Smith and understanding it should be part of your investment process.
While DS Smith isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.
About LSE:SMDS
DS Smith
Provides packaging solutions, paper products, and recycling services worldwide.
Second-rate dividend payer and slightly overvalued.
