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If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. And in light of that, the trends we're seeing at Gear4music (Holdings)'s (LON:G4M) look very promising so lets take a look.
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. The formula for this calculation on Gear4music (Holdings) is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.25 = UK£10m ÷ (UK£68m - UK£27m) (Based on the trailing twelve months to September 2020).
Therefore, Gear4music (Holdings) has an ROCE of 25%. That's a fantastic return and not only that, it outpaces the average of 11% earned by companies in a similar industry.
In the above chart we have measured Gear4music (Holdings)'s 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 report for Gear4music (Holdings).
What Does the ROCE Trend For Gear4music (Holdings) Tell Us?
The trends we've noticed at Gear4music (Holdings) are quite reassuring. The data shows that returns on capital have increased substantially over the last five years to 25%. Basically the business is earning more per dollar of capital invested and in addition to that, 351% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
On a separate but related note, it's important to know that Gear4music (Holdings) has a current liabilities to total assets ratio of 40%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
What We Can Learn From Gear4music (Holdings)'s ROCE
In summary, it's great to see that Gear4music (Holdings) 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 a remarkable 594% total return over the last five years tells us that investors are expecting more good things to come in the future. Therefore, we think it would be worth your time to check if these trends are going to continue.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Gear4music (Holdings) (of which 1 is potentially serious!) that you should know about.
Gear4music (Holdings) is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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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