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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Speaking of which, we noticed some great changes in DigitalOcean Holdings' (NYSE:DOCN) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for DigitalOcean Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.081 = US$107m ÷ (US$1.5b - US$220m) (Based on the trailing twelve months to June 2024).
Therefore, DigitalOcean Holdings has an ROCE of 8.1%. Ultimately, that's a low return and it under-performs the IT industry average of 11%.
In the above chart we have measured DigitalOcean Holdings' 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 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. The company was generating losses five years ago, but now it's earning 8.1% which is a sight for sore eyes. In addition to that, DigitalOcean Holdings is employing 541% more capital than previously which is expected of a company that's trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
One more thing to note, DigitalOcean Holdings has decreased current liabilities to 14% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. So this improvement in ROCE has come from the business' underlying economics, which is great to see.
The Key Takeaway
In summary, it's great to see that DigitalOcean Holdings has managed to break into profitability and is continuing to reinvest in its business. And since the stock has fallen 49% over the last three years, there might be an opportunity here. So researching this company further and determining whether or not these trends will continue seems justified.
If you want to know some of the risks facing DigitalOcean Holdings we've found 4 warning signs (2 shouldn't be ignored!) that you should be aware of before investing here.
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.
