Direct Digital Holdings (NASDAQ:DRCT) Knows How To Allocate Capital Effectively

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. 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?

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 Direct Digital Holdings:

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

0.20 = US$6.4m ÷ (US$62m - US$30m) (Based on the trailing twelve months to June 2023).

So, Direct Digital Holdings has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Media industry average of 8.2%.

View our latest analysis for Direct Digital Holdings

In the above chart we have measured Direct Digital Holdings' prior ROCE against its prior performance, but the future is arguably more important. 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?

We're delighted to see that Direct Digital Holdings is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses three years ago, but now it's earning 20% which is a sight for sore eyes. In addition to that, Direct Digital Holdings is employing 164% more capital than previously which is expected of a company that's 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.

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. Essentially the business now has suppliers or short-term creditors funding about 49% of its operations, which isn't ideal. And with current liabilities at those levels, that's pretty high.

The Bottom Line

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. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 9.8% return over the last year. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

One final note, you should learn about the 3 warning signs we've spotted with Direct Digital Holdings (including 1 which is potentially serious) .

Direct Digital Holdings is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.