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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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Although, when we looked at Digital Media Solutions (NYSE:DMS), it didn't seem to tick all of these boxes.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Digital Media Solutions is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.045 = US$7.8m ÷ (US$241m - US$69m) (Based on the trailing twelve months to March 2022).
Thus, Digital Media Solutions has an ROCE of 4.5%. In absolute terms, that's a low return and it also under-performs the Media industry average of 7.1%.
In the above chart we have measured Digital Media Solutions' 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 report for Digital Media Solutions.
What Can We Tell From Digital Media Solutions' ROCE Trend?
When we looked at the ROCE trend at Digital Media Solutions, we didn't gain much confidence. Around three years ago the returns on capital were 36%, but since then they've fallen to 4.5%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
On a related note, Digital Media Solutions has decreased its current liabilities to 28% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
The Bottom Line On Digital Media Solutions' ROCE
While returns have fallen for Digital Media Solutions in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. But since the stock has dived 84% in the last three years, there could be other drivers that are influencing the business' outlook. Therefore, we'd suggest researching the stock further to uncover more about the business.
On a final note, we found 2 warning signs for Digital Media Solutions (1 shouldn't be ignored) you should be aware of.
While Digital Media Solutions 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.