Daqo New Energy (NYSE:DQ) Knows How To Allocate Capital Effectively

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. And in light of that, the trends we're seeing at Daqo New Energy's (NYSE:DQ) look very promising so lets take a look.

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. Analysts use this formula to calculate it for Daqo New Energy:

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

0.44 = US$2.6b ÷ (US$6.9b - US$910m) (Based on the trailing twelve months to September 2022).

Thus, Daqo New Energy has an ROCE of 44%. In absolute terms that's a great return and it's even better than the Semiconductor industry average of 15%.

Check out our latest analysis for Daqo New Energy

In the above chart we have measured Daqo New Energy's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Daqo New Energy here for free.

What Does the ROCE Trend For Daqo New Energy Tell Us?

We like the trends that we're seeing from Daqo New Energy. Over the last five years, returns on capital employed have risen substantially to 44%. The amount of capital employed has increased too, by 1,120%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 13%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. This tells us that Daqo New Energy has grown its returns without a reliance on increasing their current liabilities, which we're very happy with.

What We Can Learn From Daqo New Energy's ROCE

A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Daqo New Energy has. Since the stock has returned a staggering 337% to shareholders over the last five years, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if Daqo New Energy can keep these trends up, it could have a bright future ahead.

One more thing to note, we've identified 2 warning signs with Daqo New Energy and understanding them should be part of your investment process.

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.

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

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.