Direct Digital Holdings (NASDAQ:DRCT) Could Become A Multi-Bagger

There are a few key trends to look for if we want to identify the next multi-bagger. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. So when we looked at the ROCE trend of Direct Digital Holdings (NASDAQ:DRCT) we really liked what we saw.

What Is 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 Direct Digital Holdings:

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

0.23 = US$7.3m ÷ (US$53m - US$22m) (Based on the trailing twelve months to March 2023).

Thus, Direct Digital Holdings has an ROCE of 23%. That's a fantastic return and not only that, it outpaces the average of 9.7% earned by companies in a similar industry.

See our latest analysis for Direct Digital Holdings

Above you can see how the current ROCE for Direct Digital Holdings 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 report on analyst forecasts for the company.

The Trend Of ROCE

We're delighted to see that Direct Digital Holdings is reaping rewards from its investments and is now generating some pre-tax profits. Shareholders would no doubt be pleased with this because the business was loss-making three years ago but is is now generating 23% on its capital. Not only that, but the company is utilizing 415% more capital than before, but that's to be expected from a company trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

On a separate but related note, it's important to know that Direct Digital Holdings has a current liabilities to total assets ratio of 41%, which we'd consider pretty high. 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.

What We Can Learn From Direct Digital Holdings' ROCE

In summary, it's great to see that Direct Digital Holdings has managed to break into profitability and is continuing to reinvest in its business. Since the stock has returned a solid 57% to shareholders over the last year, it's fair to say investors are beginning to recognize these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Direct Digital Holdings (of which 1 is concerning!) that you should know about.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning 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.