There are a few key trends to look for if we want to identify the next multi-bagger. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So on that note, Duolingo (NASDAQ:DUOL) looks quite promising in regards to its trends of return on capital.

What Is Return On Capital Employed (ROCE)?

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 Duolingo:

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

0.016 = US$12m ÷ (US$1.1b - US$304m) (Based on the trailing twelve months to March 2024).

Thus, Duolingo has an ROCE of 1.6%. Ultimately, that's a low return and it under-performs the Consumer Services industry average of 7.6%.

Above you can see how the current ROCE for Duolingo compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Duolingo for free.

How Are Returns Trending?

Duolingo has recently broken into profitability so their prior investments seem to be paying off. The company was generating losses four years ago, but now it's earning 1.6% which is a sight for sore eyes. And unsurprisingly, like most companies trying to break into the black, Duolingo is utilizing 925% more capital than it was four years ago. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.

Our Take On Duolingo's ROCE

Overall, Duolingo gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. And with a respectable 26% awarded to those who held the stock over the last year, you could argue that these developments are starting to get the attention they deserve. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

One more thing to note, we've identified 1 warning sign with Duolingo and understanding this should be part of your investment process.

While Duolingo 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.

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