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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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Digi International (NASDAQ:DGII) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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. To calculate this metric for Digi International, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.038 = US$30m ÷ (US$870m - US$90m) (Based on the trailing twelve months to March 2022).
Therefore, Digi International has an ROCE of 3.8%. In absolute terms, that's a low return and it also under-performs the Communications industry average of 9.0%.
Above you can see how the current ROCE for Digi International compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Digi International here for free.
What Can We Tell From Digi International's ROCE Trend?
The returns on capital haven't changed much for Digi International in recent years. The company has consistently earned 3.8% for the last five years, and the capital employed within the business has risen 145% in that time. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
Our Take On Digi International's ROCE
Long story short, while Digi International has been reinvesting its capital, the returns that it's generating haven't increased. Yet to long term shareholders the stock has gifted them an incredible 131% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
Digi International does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those can't be ignored...
While Digi International may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.