What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. And in light of that, the trends we're seeing at Direct Digital Holdings' (NASDAQ:DRCT) look very promising so lets take a look.
Return On Capital Employed (ROCE): What Is It?
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 Direct Digital Holdings is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.29 = US$9.7m ÷ (US$87m - US$53m) (Based on the trailing twelve months to September 2023).
Thus, Direct Digital Holdings has an ROCE of 29%. In absolute terms that's a great return and it's even better than the Media industry average of 8.2%.
In the above chart we have measured Direct Digital Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Direct Digital Holdings .
What Can We Tell From Direct Digital Holdings' ROCE Trend?
The fact that Direct Digital Holdings is now generating some pre-tax profits from its prior investments is very encouraging. About three years ago the company was generating losses but things have turned around because it's now earning 29% on its capital. In addition to that, Direct Digital Holdings is employing 88% more capital than previously which is expected of a company that's trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.
For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 61% of the business, which is more than it was three years ago. And with current liabilities at those levels, that's pretty high.
The Key Takeaway
Long story short, we're delighted to see that Direct Digital Holdings' reinvestment activities have paid off and the company is now profitable. Since the stock has returned a staggering 566% to shareholders over the last year, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if Direct Digital Holdings can keep these trends up, it could have a bright future ahead.
Like most companies, Direct Digital Holdings does come with some risks, and we've found 2 warning signs that you should be aware of.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning 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.