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We Like These Underlying Return On Capital Trends At GMS (NYSE:GMS)

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What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at GMS (NYSE:GMS) and its trend of ROCE, we really liked what we saw.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for GMS, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.088 = US$165m ÷ (US$2.3b - US$380m) (Based on the trailing twelve months to January 2021).

So, GMS has an ROCE of 8.8%. On its own, that's a low figure but it's around the 8.5% average generated by the Trade Distributors industry.

Check out our latest analysis for GMS

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Above you can see how the current ROCE for GMS compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

So How Is GMS' ROCE Trending?

While in absolute terms it isn't a high ROCE, it's promising to see that it has been moving in the right direction. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 8.8%. Basically the business is earning more per dollar of capital invested and in addition to that, 81% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

The Key Takeaway

To sum it up, GMS has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 40% return over the last three years. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 5 warning signs for GMS (of which 1 is significant!) that you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.