There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at DXP Enterprises (NASDAQ:DXPE) and its ROCE trend, we weren't exactly thrilled.
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. Analysts use this formula to calculate it for DXP Enterprises:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.014 = US$9.8m ÷ (US$869m - US$153m) (Based on the trailing twelve months to March 2021).
So, DXP Enterprises has an ROCE of 1.4%. Ultimately, that's a low return and it under-performs the Trade Distributors industry average of 9.2%.
In the above chart we have measured DXP Enterprises' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for DXP Enterprises.
So How Is DXP Enterprises' ROCE Trending?
When we looked at the ROCE trend at DXP Enterprises, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 1.4% from 13% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
On a side note, DXP Enterprises has done well to pay down its current liabilities to 18% of total assets. Since the ratio used to be 70%, that's a significant reduction and it no doubt explains the drop 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.
We're a bit apprehensive about DXP Enterprises because despite more capital being deployed in the business, returns on that capital and sales have both fallen. However the stock has delivered a 88% return to shareholders over the last five years, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
DXP Enterprises does have some risks, we noticed 3 warning signs (and 1 which is a bit concerning) we think you should know about.
While DXP Enterprises may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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