Capital Allocation Trends At dotdigital Group (LON:DOTD) Aren't Ideal

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at dotdigital Group (LON:DOTD), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What Is It?

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. The formula for this calculation on dotdigital Group is:

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

0.14 = UK£14m ÷ (UK£116m - UK£16m) (Based on the trailing twelve months to December 2023).

Therefore, dotdigital Group has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Software industry average of 10% it's much better.

See our latest analysis for dotdigital Group

In the above chart we have measured dotdigital Group'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 analyst report for dotdigital Group .

What Can We Tell From dotdigital Group's ROCE Trend?

When we looked at the ROCE trend at dotdigital Group, we didn't gain much confidence. Around five years ago the returns on capital were 23%, but since then they've fallen to 14%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

In Conclusion...

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for dotdigital Group. These trends don't appear to have influenced returns though, because the total return from the stock has been mostly flat over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you'd like to know about the risks facing dotdigital Group, we've discovered 1 warning sign that you should be aware of.

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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.