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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'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Gresham Technologies (LON:GHT) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Understanding 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. Analysts use this formula to calculate it for Gresham Technologies:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.03 = UK£855k ÷ (UK£42m - UK£14m) (Based on the trailing twelve months to December 2019).
Therefore, Gresham Technologies has an ROCE of 3.0%. Ultimately, that's a low return and it under-performs the Software industry average of 9.5%.
In the above chart we have a measured Gresham Technologies' 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 Gresham Technologies.
What Can We Tell From Gresham Technologies' ROCE Trend?
There are better returns on capital out there than what we're seeing at Gresham Technologies. The company has employed 119% more capital in the last five years, and the returns on that capital have remained stable at 3.0%. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
The Bottom Line On Gresham Technologies' ROCE
Long story short, while Gresham Technologies has been reinvesting its capital, the returns that it's generating haven't increased. Unsurprisingly, the stock has only gained 33% over the last five years, which potentially indicates that investors are accounting for this going forward. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.
If you'd like to know about the risks facing Gresham Technologies, we've discovered 1 warning sign that you should be aware of.
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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