D4t4 Solutions (LON:D4T4) May Have Issues Allocating Its Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think D4t4 Solutions (LON:D4T4) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is 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 D4t4 Solutions, this is the formula:

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

0.10 = UK£2.8m ÷ (UK£31m - UK£3.6m) (Based on the trailing twelve months to September 2020).

Therefore, D4t4 Solutions has an ROCE of 10.0%. On its own that's a low return on capital but it's in line with the industry's average returns of 10.0%.

Check out our latest analysis for D4t4 Solutions

Above you can see how the current ROCE for D4t4 Solutions compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering D4t4 Solutions here for free.

What Does the ROCE Trend For D4t4 Solutions Tell Us?

In terms of D4t4 Solutions' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 18%, but since then they've fallen to 10.0%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

What We Can Learn From D4t4 Solutions' ROCE

We're a bit apprehensive about D4t4 Solutions because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Yet despite these poor fundamentals, the stock has gained a huge 120% over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

D4t4 Solutions could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.

While D4t4 Solutions 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. 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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