Here's What's Concerning About Digital Media Solutions' (NYSE:DMS) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. In light of that, when we looked at Digital Media Solutions (NYSE:DMS) and its ROCE trend, we weren't exactly thrilled.

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. To calculate this metric for Digital Media Solutions, this is the formula:

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

0.07 = US$13m ÷ (US$247m - US$67m) (Based on the trailing twelve months to December 2021).

Therefore, Digital Media Solutions has an ROCE of 7.0%. On its own that's a low return on capital but it's in line with the industry's average returns of 6.8%.

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

When we looked at the ROCE trend at Digital Media Solutions, we didn't gain much confidence. Around three years ago the returns on capital were 55%, but since then they've fallen to 7.0%. 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 side note, Digital Media Solutions has done well to pay down its current liabilities to 27% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Digital Media Solutions' ROCE

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. But since the stock has dived 77% in the last three years, there could be other drivers that are influencing the business' outlook. Regardless, reinvestment can pay off in the long run, so we think astute investors may want to look further into this stock.

If you'd like to know more about Digital Media Solutions, we've spotted 3 warning signs, and 2 of them shouldn't be ignored.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.