DNO (OB:DNO) Could Be Struggling To Allocate Capital

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. Basically the company is earning less on its investments and it is also reducing its total assets. And from a first read, things don't look too good at DNO (OB:DNO), so let's see why.

Understanding 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. Analysts use this formula to calculate it for DNO:

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

0.059 = US$155m ÷ (US$3.0b - US$322m) (Based on the trailing twelve months to June 2024).

Therefore, DNO has an ROCE of 5.9%. Ultimately, that's a low return and it under-performs the Oil and Gas industry average of 17%.

See our latest analysis for DNO

Above you can see how the current ROCE for DNO compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for DNO .

How Are Returns Trending?

There is reason to be cautious about DNO, given the returns are trending downwards. To be more specific, the ROCE was 14% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on DNO becoming one if things continue as they have.

What We Can Learn From DNO's ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. In spite of that, the stock has delivered a 27% return to shareholders who held over the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

DNO does have some risks, we noticed 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.