Daqo New Energy's (NYSE:DQ) Returns On Capital Not Reflecting Well On The Business

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. However, after investigating Daqo New Energy (NYSE:DQ), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

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 Daqo New Energy is:

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

0.054 = US$350m ÷ (US$7.2b - US$720m) (Based on the trailing twelve months to March 2024).

Thus, Daqo New Energy has an ROCE of 5.4%. In absolute terms, that's a low return and it also under-performs the Semiconductor industry average of 9.7%.

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 for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Daqo New Energy doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.4% from 6.9% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

The Bottom Line On Daqo New Energy's ROCE

In summary, we're somewhat concerned by Daqo New Energy's diminishing returns on increasing amounts of capital. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 91% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Daqo New Energy does have some risks though, and we've spotted 2 warning signs for Daqo New Energy that you might be interested in.

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.

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