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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. 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Gentherm (NASDAQ:THRM) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper 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 Gentherm, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = US$74m ÷ (US$921m - US$191m) (Based on the trailing twelve months to September 2020).
Therefore, Gentherm has an ROCE of 10%. By itself that's a normal return on capital and it's in line with the industry's average returns of 10%.
In the above chart we have measured Gentherm'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 Gentherm here for free.
So How Is Gentherm's ROCE Trending?
In terms of Gentherm's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 24% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
What We Can Learn From Gentherm's ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for Gentherm have fallen, meanwhile the business is employing more capital than it was five years ago. In spite of that, the stock has delivered a 32% return to shareholders who held over the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
If you want to continue researching Gentherm, you might be interested to know about the 1 warning sign that our analysis has discovered.
While Gentherm isn't earning the highest return, check out this free list of companies that are 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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