If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at DLH Holdings (NASDAQ:DLHC), it didn't seem to tick all of these boxes.

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 DLH Holdings:

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

0.099 = US$26m ÷ (US$325m - US$58m) (Based on the trailing twelve months to June 2024).

Therefore, DLH Holdings has an ROCE of 9.9%. In absolute terms, that's a low return and it also under-performs the Professional Services industry average of 14%.

Check out our latest analysis for DLH Holdings

In the above chart we have measured DLH Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering DLH Holdings for free.

How Are Returns Trending?

In terms of DLH Holdings' historical ROCE trend, it doesn't exactly demand attention. The company has employed 149% more capital in the last five years, and the returns on that capital have remained stable at 9.9%. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.

The Bottom Line

As we've seen above, DLH Holdings' returns on capital haven't increased but it is reinvesting in the business. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 115% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One final note, you should learn about the 4 warning signs we've spotted with DLH Holdings (including 1 which is potentially serious) .

While DLH Holdings 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.