What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Darco Water Technologies (SGX:BLR), it didn't seem to tick all of these boxes.

What Is 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. Analysts use this formula to calculate it for Darco Water Technologies:

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

0.026 = S$1.2m ÷ (S$84m - S$40m) (Based on the trailing twelve months to June 2023).

Therefore, Darco Water Technologies has an ROCE of 2.6%. Ultimately, that's a low return and it under-performs the Machinery industry average of 5.4%.

View our latest analysis for Darco Water Technologies

Historical performance is a great place to start when researching a stock so above you can see the gauge for Darco Water Technologies' ROCE against it's prior returns. If you're interested in investigating Darco Water Technologies' past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

We're a bit concerned with the trends, because the business is applying 26% less capital than it was five years ago and returns on that capital have stayed flat. This indicates to us that assets are being sold and thus the business is likely shrinking, which you'll remember isn't the typical ingredients for an up-and-coming multi-bagger. Not only that, but the low returns on this capital mentioned earlier would leave most investors unimpressed.

On a separate but related note, it's important to know that Darco Water Technologies has a current liabilities to total assets ratio of 48%, 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line

It's a shame to see that Darco Water Technologies is effectively shrinking in terms of its capital base. It seems that investors have little hope of these trends getting any better and that may have partly contributed to the stock collapsing 77% in the last five years. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

If you'd like to know about the risks facing Darco Water Technologies, we've discovered 3 warning signs that you should be aware of.

While Darco Water Technologies 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.