Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at Downer EDI (ASX:DOW) and its trend of ROCE, we really liked what we saw.

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What Is 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. Analysts use this formula to calculate it for Downer EDI:

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).

Therefore, Downer EDI has an ROCE of 8.0%. Ultimately, that's a low return and it under-performs the Commercial Services industry average of 11%.

See 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'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Downer EDI .

So How Is Downer EDI's ROCE Trending?

We're pretty happy with how the ROCE has been trending at Downer EDI. The data shows that returns on capital have increased by 24% over the trailing five years. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. Interestingly, the business may be becoming more efficient because it's applying 36% less capital than it was five years ago. If this trend continues, the business might be getting more efficient but it's shrinking in terms of total assets.

On a side note, Downer EDI's current liabilities are still rather high at 41% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

In a nutshell, we're pleased to see that Downer EDI has been able to generate higher returns from less capital. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 63% return over the last five years. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

One more thing, we've spotted 2 warning signs facing Downer EDI that you might find interesting.

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Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.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.