If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. That's why when we briefly looked at GUD Holdings' (ASX:GUD) ROCE trend, we were pretty happy with what we saw.
What is Return On Capital Employed (ROCE)?
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 GUD Holdings is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = AU$81m ÷ (AU$644m - AU$97m) (Based on the trailing twelve months to June 2020).
So, GUD Holdings has an ROCE of 15%. By itself that's a normal return on capital and it's in line with the industry's average returns of 15%.
In the above chart we have measured GUD Holdings' 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 GUD Holdings.
What Does the ROCE Trend For GUD Holdings Tell Us?
The trend of ROCE doesn't stand out much, but returns on a whole are decent. The company has consistently earned 15% for the last five years, and the capital employed within the business has risen 42% in that time. Since 15% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.
On a side note, GUD Holdings has done well to reduce current liabilities to 15% of total assets over the last five years. Effectively suppliers now fund less of the business, which can lower some elements of risk.
The Bottom Line On GUD Holdings' ROCE
The main thing to remember is that GUD Holdings has proven its ability to continually reinvest at respectable rates of return. And the stock has followed suit returning a meaningful 69% to shareholders over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
On a separate note, we've found 2 warning signs for GUD Holdings you'll probably want to know about.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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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