Did you know there are some financial metrics that can provide clues of a potential 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.
Understanding 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. The formula for this calculation on Duolingo is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.062 = US$54m ÷ (US$1.2b - US$342m) (Based on the trailing twelve months to September 2024).
Therefore, Duolingo has an ROCE of 6.2%. Ultimately, that's a low return and it under-performs the Consumer Services industry average of 9.2%.
In the above chart we have measured Duolingo's 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 Duolingo for free.
What Does the ROCE Trend For Duolingo Tell Us?
Duolingo has recently broken into profitability so their prior investments seem to be paying off. About four years ago the company was generating losses but things have turned around because it's now earning 6.2% on its capital. Not only that, but the company is utilizing 793% more capital than before, but that's to be expected from a company trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.
What We Can Learn From Duolingo's ROCE
In summary, it's great to see that Duolingo has managed to break into profitability and is continuing to reinvest in its business. And a remarkable 241% total return over the last three years tells us that investors are expecting more good things to come in the future. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
Like most companies, Duolingo does come with some risks, and we've found 2 warning signs that you should be aware of.
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.
