Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at DigitalOcean Holdings (NYSE:DOCN) and its trend of ROCE, we really liked what we saw.

Understanding 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)

0.053 = US$67m ÷ (US$1.5b - US$193m) (Based on the trailing twelve months to December 2023).

So, DigitalOcean Holdings has an ROCE of 5.3%. In absolute terms, that's a low return and it also under-performs the IT industry average of 13%.

Above you can see how the current ROCE for DigitalOcean Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for DigitalOcean Holdings .

What Can We Tell From DigitalOcean Holdings' ROCE Trend?

We're delighted to see that DigitalOcean Holdings is reaping rewards from its investments and is now generating some pre-tax profits. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 5.3% on its capital. In addition to that, DigitalOcean Holdings is employing 599% more capital than previously which is expected of a company that's trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

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. Astute investors may have an opportunity here because the stock has declined 17% in the last three years. So researching this company further and determining whether or not these trends will continue seems justified.

DigitalOcean Holdings does come with some risks though, we found 3 warning signs in our investment analysis, and 2 of those don't sit too well with us...

While DigitalOcean Holdings isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.