There are a few key trends to look for if we want to identify the next multi-bagger. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at Dell Technologies (NYSE:DELL) and its trend of ROCE, we really liked what we saw.
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 Dell Technologies is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.091 = US$6.0b ÷ (US$136b - US$70b) (Based on the trailing twelve months to October 2021).
So, Dell Technologies has an ROCE of 9.1%. On its own that's a low return on capital but it's in line with the industry's average returns of 9.2%.
In the above chart we have measured Dell Technologies' 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 Dell Technologies here for free.
How Are Returns Trending?
It's great to see that Dell Technologies has started to generate some pre-tax earnings from prior investments. Historically the company was generating losses but as we can see from the latest figures referenced above, they're now earning 9.1% on their capital employed. Additionally, the business is utilizing 22% less capital than it was five years ago, and taken at face value, that can mean the company needs less funds at work to get a return. Dell Technologies could be selling under-performing assets since the ROCE is improving.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 51% of its operations, which isn't ideal. And with current liabilities at those levels, that's pretty high.
In the end, Dell Technologies has proven it's capital allocation skills are good with those higher returns from less amount of capital. And with the stock having performed exceptionally well over the last three years, these patterns are being accounted for by investors. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
If you'd like to know more about Dell Technologies, we've spotted 5 warning signs, and 1 of them is significant.
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.