Digicontent's (NSE:DGCONTENT) Returns On Capital Tell Us There Is Reason To Feel Uneasy

When researching a stock for investment, what can tell us that the company is in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. In light of that, from a first glance at Digicontent (NSE:DGCONTENT), we've spotted some signs that it could be struggling, so let's investigate.

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. The formula for this calculation on Digicontent is:

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

0.095 = ₹92m ÷ (₹1.6b - ₹633m) (Based on the trailing twelve months to June 2021).

So, Digicontent has an ROCE of 9.5%. On its own, that's a low figure but it's around the 9.0% average generated by the Interactive Media and Services industry.

Check out our latest analysis for Digicontent

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Digicontent, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

The trend of returns that Digicontent is generating are raising some concerns. The company used to generate 16% on its capital two years ago but it has since fallen noticeably. On top of that, the business is utilizing 38% less capital within its operations. The fact that both are shrinking is an indication that the business is going through some tough times. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 40%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

The Bottom Line On Digicontent's ROCE

To see Digicontent reducing the capital employed in the business in tandem with diminishing returns, is concerning. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 156%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

On a final note, we found 4 warning signs for Digicontent (2 are a bit concerning) you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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