Be Wary Of Digital Media Solutions (NYSE:DMS) And Its Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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 Digital Media Solutions (NYSE:DMS) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. The formula for this calculation on Digital Media Solutions is:

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

0.096 = US$20m ÷ (US$269m - US$57m) (Based on the trailing twelve months to June 2021).

Therefore, Digital Media Solutions has an ROCE of 9.6%. Even though it's in line with the industry average of 9.9%, it's still a low return by itself.

See our latest analysis for Digital Media Solutions

Above you can see how the current ROCE for Digital Media Solutions compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Digital Media Solutions here for free.

The Trend Of ROCE

In terms of Digital Media Solutions' historical ROCE movements, the trend isn't fantastic. Over the last two years, returns on capital have decreased to 9.6% from 27% two years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Digital Media Solutions has decreased its current liabilities to 21% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Digital Media Solutions is reinvesting for growth and has higher sales as a result. In light of this, the stock has only gained 0.5% over the last year. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

Digital Media Solutions does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those can't be ignored...

While Digital Media Solutions 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.

When trading Digital Media Solutions or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.