There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. Although, when we looked at Douglas Dynamics (NYSE:PLOW), it didn't seem to tick all of these boxes.

Understanding 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. The formula for this calculation on Douglas Dynamics is:

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

0.12 = US$54m ÷ (US$577m - US$122m) (Based on the trailing twelve months to March 2024).

So, Douglas Dynamics has an ROCE of 12%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Machinery industry average of 13%.

In the above chart we have measured Douglas Dynamics' 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 Douglas Dynamics .

What The Trend Of ROCE Can Tell Us

We've noticed that although returns on capital are flat over the last five years, the amount of capital employed in the business has fallen 26% in that same period. To us that doesn't look like a multi-bagger because the company appears to be selling assets and it's returns aren't increasing. You could assume that if this continues, the business will be smaller in a few year time, so probably not a multi-bagger.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 21% of total assets, this reported ROCE would probably be less than12% because total capital employed would be higher.The 12% ROCE could be even lower if current liabilities weren't 21% of total assets, because the the formula would show a larger base of total capital employed. With that in mind, just be wary if this ratio increases in the future, because if it gets particularly high, this brings with it some new elements of risk.

What We Can Learn From Douglas Dynamics' ROCE

Overall, we're not ecstatic to see Douglas Dynamics reducing the amount of capital it employs in the business. Since the stock has declined 30% over the last five years, investors may not be too optimistic on this trend improving either. 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.

Douglas Dynamics does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is a bit unpleasant...

While Douglas Dynamics 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.

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