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. Amongst other things, we’ll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company’s amount of capital employed. Ultimately, this demonstrates that it’s a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Darling Ingredients (NYSE:DAR) we aren’t jumping out of our chairs at how returns are trending, but let’s have a deeper look.
Return On Capital Employed (ROCE): What is it?
Just to clarify if you’re unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Darling Ingredients:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.031 = US$153m ÷ (US$5.6b – US$675m) (Based on the trailing twelve months to January 2021).
Therefore, Darling Ingredients has an ROCE of 3.1%. In absolute terms, that’s a low return and it also under-performs the Food industry average of 8.4%.
In the above chart we have measured Darling Ingredients’ prior ROCE against its prior performance, but the future is arguably more important.
What Does the ROCE Trend For Darling Ingredients Tell Us?
There hasn’t been much to report for Darling Ingredients’ returns and its level of capital employed because both metrics have been steady for the past five years. It’s not uncommon to see this when looking at a mature and stable business that isn’t re-investing its earnings because it has likely passed that phase of the business cycle. So unless we see a substantial change at Darling Ingredients in terms of ROCE and additional investments being made, we wouldn’t hold our breath on it being a multi-bagger.
The Bottom Line On Darling Ingredients’ ROCE
In summary, Darling Ingredients isn’t compounding its earnings but is generating stable returns on the same amount of capital employed. Investors must think there’s better things to come because the stock has knocked it out of the park, delivering a 374% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn’t high.