Here's What To Make Of Darco Water Technologies' (SGX:BLR) Decelerating Rates Of Return

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don't think Darco Water Technologies (SGX:BLR) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Darco Water Technologies, this is the formula:

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

0.026 = S$1.2m ÷ (S$84m - S$40m) (Based on the trailing twelve months to June 2023).

So, Darco Water Technologies has an ROCE of 2.6%. Ultimately, that's a low return and it under-performs the Machinery industry average of 6.1%.

Check out our latest analysis for Darco Water Technologies

Historical performance is a great place to start when researching a stock so above you can see the gauge for Darco Water Technologies' ROCE against it's prior returns. If you're interested in investigating Darco Water Technologies' past further, check out this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

We've noticed that although returns on capital are flat over the last five years, the amount of capital employed in the business has fallen 26% in that same period. To us that doesn't look like a multi-bagger because the company appears to be selling assets and it's returns aren't increasing. Not only that, but the low returns on this capital mentioned earlier would leave most investors unimpressed.

Another thing to note, Darco Water Technologies has a high ratio of current liabilities to total assets of 48%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

It's a shame to see that Darco Water Technologies is effectively shrinking in terms of its capital base. And investors may be expecting the fundamentals to get a lot worse because the stock has crashed 79% over the last five years. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

One more thing to note, we've identified 3 warning signs with Darco Water Technologies and understanding these should be part of your investment process.

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.