Be Wary Of Digital Value (BIT:DGV) And Its Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Looking at Digital Value (BIT:DGV), it does have a high ROCE right now, but lets see how returns are trending.

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. The formula for this calculation on Digital Value is:

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

0.22 = €44m ÷ (€540m - €335m) (Based on the trailing twelve months to December 2021).

Thus, Digital Value has an ROCE of 22%. That's a fantastic return and not only that, it outpaces the average of 8.9% earned by companies in a similar industry.

See our latest analysis for Digital Value

In the above chart we have measured Digital Value'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

On the surface, the trend of ROCE at Digital Value doesn't inspire confidence. Historically returns on capital were even higher at 38%, but they have dropped over the last three years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Digital Value has decreased its current liabilities to 62% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 62% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line On Digital Value's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Digital Value. And the stock has done incredibly well with a 303% return over the last three years, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we'd be optimistic on the stock going forward.

One final note, you should learn about the 2 warning signs we've spotted with Digital Value (including 1 which shouldn't be ignored) .

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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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.