This analysis is intended to introduce important early concepts to people who are starting to invest and want a simplistic look at the return on Digital Bros SpA (BIT:DIB) stock.
Purchasing Digital Bros gives you an ownership stake in the company. This share represents a portion of capital used by the company to operate the business, and it is important the company is able to use the capital base efficiently to create adequate cash flows for you as an investor. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. Thus, to understand how your money can grow by investing in Digital Bros, you need to look at what the company returns to owners for the use of their capital, which can be done in many ways but today we will use return on capital employed (ROCE).View out our latest analysis for Digital Bros
Calculating Return On Capital Employed for DIB
When you choose to invest in a company, there is an opportunity cost because that money could’ve been invested elsewhere. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if Digital Bros is good at growing investor capital. Take a look at the formula box beneath:
ROCE Calculation for DIB
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = €7.57m ÷ (€99.42m – €26.14m) = 10.32%
As you can see, DIB earned €10.3 from every €100 you invested over the previous twelve months. Comparing this to a healthy 15% benchmark shows Digital Bros is currently unable to return a desired amount to owners for the use of their capital, which isn’t favourable for investors who have forgone other potentially solid companies.
Why is this the case?
Although Digital Bros is in an unfavourable position, you should know that this could change if the company is able to increase earnings on the same capital base or find new efficiencies that require less capital to produce earnings. Therefore, investors need to understand the trend of the inputs in the formula above, so that they can see if there is an opportunity to invest. Looking three years in the past, it is evident that DIB’s ROCE has deteriorated from 37.94%, indicating the company’s capital returns have declined. With this, the current earnings of €7.57m actually declined from €11.94m whilst capital employed has increased due to a rise in total assets and a smaller reliance on current liabilities (less borrowing to fund operations) , which means the company’s ROCE has shrunk as a result of falling earnings and simultaneous increases in capital requirements.
DIB’s investors have experienced a downward trend in ROCE and it is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. But don’t forget, return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like the management team. Digital Bros’s fundamentals can be explored with the links I’ve provided below if you are interested, otherwise you can start looking at other high-performing stocks.
- Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for Digital Bros’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.