DigitalOcean Holdings (NYSE:DOCN) Is Looking To Continue Growing Its Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. So on that note, DigitalOcean Holdings (NYSE:DOCN) looks quite promising in regards to its trends of return on capital.

What Is Return On Capital Employed (ROCE)?

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. The formula for this calculation on DigitalOcean Holdings is:

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

0.022 = US$27m ÷ (US$1.4b - US$184m) (Based on the trailing twelve months to September 2023).

So, DigitalOcean Holdings has an ROCE of 2.2%. In absolute terms, that's a low return and it also under-performs the IT industry average of 12%.

Check out our latest analysis for DigitalOcean Holdings

In the above chart we have measured DigitalOcean 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 DigitalOcean Holdings' ROCE Trending?

The fact that DigitalOcean Holdings is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making four years ago but is is now generating 2.2% on its capital. Not only that, but the company is utilizing 470% more capital than before, but that's to be expected from a company trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

On a related note, the company's ratio of current liabilities to total assets has decreased to 13%, which basically reduces it's funding from the likes of short-term creditors or suppliers. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.

What We Can Learn From DigitalOcean Holdings' ROCE

Overall, DigitalOcean Holdings gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Since the stock has returned a solid 7.1% to shareholders over the last year, it's fair to say investors are beginning to recognize these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for DigitalOcean Holdings (of which 1 is significant!) that you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.