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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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Gamma Communications' (LON:GAMA) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What is it?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Gamma Communications, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.26 = UK£51m ÷ (UK£277m - UK£78m) (Based on the trailing twelve months to June 2020).
Therefore, Gamma Communications has an ROCE of 26%. That's a fantastic return and not only that, it outpaces the average of 7.8% earned by companies in a similar industry.
In the above chart we have measured Gamma Communications' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Does the ROCE Trend For Gamma Communications Tell Us?
Gamma Communications is displaying some positive trends. Over the last five years, returns on capital employed have risen substantially to 26%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 255%. So we're very much inspired by what we're seeing at Gamma Communications thanks to its ability to profitably reinvest capital.
Our Take On Gamma Communications' ROCE
In summary, it's great to see that Gamma Communications can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. 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.
Gamma Communications does have some risks though, and we've spotted 1 warning sign for Gamma Communications that you might be interested in.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
This article by Simply Wall St is general in nature. 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.
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