Direct Digital Holdings (NASDAQ:DRCT) Is Achieving High Returns On Its Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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.

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. The formula for this calculation on Direct Digital Holdings is:

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

0.23 = US$7.3m ÷ (US$54m - US$22m) (Based on the trailing twelve months to September 2022).

Thus, Direct Digital Holdings has an ROCE of 23%. In absolute terms that's a great return and it's even better than the Media industry average of 9.3%.

Check out 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.

So How Is Direct Digital Holdings' ROCE Trending?

The fact that Direct Digital Holdings is now generating some pre-tax profits from its prior investments is very encouraging. About two years ago the company was generating losses but things have turned around because it's now earning 23% on its capital. In addition to that, Direct Digital Holdings is employing 74% more capital than previously which is expected of a company that's trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 42% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. And with current liabilities at those levels, that's pretty high.

The Bottom Line On Direct Digital Holdings' ROCE

Long story short, we're delighted to see that Direct Digital Holdings' reinvestment activities have paid off and the company is now profitable. And with the stock having performed exceptionally well over the last year, these patterns are being accounted for by investors. Therefore, we think it would be worth your time to check if these trends are going to continue.

On a final note, we found 5 warning signs for Direct Digital Holdings (1 is a bit concerning) you should be aware of.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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.