Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 on that note, Downer EDI (ASX:DOW) looks quite promising in regards to its trends of return on capital.

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Return On Capital Employed (ROCE): What Is It?

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 Downer EDI, this is the formula:

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

0.08 = AU$295m ÷ (AU$6.2b - AU$2.5b) (Based on the trailing twelve months to December 2024).

Thus, Downer EDI has an ROCE of 8.0%. In absolute terms, that's a low return and it also under-performs the Commercial Services industry average of 11%.

Check out our latest analysis for Downer EDI

In the above chart we have measured Downer EDI's 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 analyst report for Downer EDI .

What Can We Tell From Downer EDI's ROCE Trend?

We're pretty happy with how the ROCE has been trending at Downer EDI. The figures show that over the last five years, returns on capital have grown by 24%. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. In regards to capital employed, Downer EDI appears to been achieving more with less, since the business is using 36% less capital to run its operation. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.

On a separate but related note, it's important to know that Downer EDI has a current liabilities to total assets ratio of 41%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

From what we've seen above, Downer EDI has managed to increase it's returns on capital all the while reducing it's capital base. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 70% return over the last five years. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

If you'd like to know about the risks facing Downer EDI, we've discovered 2 warning signs that you should be aware of.

While Downer EDI 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.