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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. And in light of that, the trends we're seeing at Gear4music (Holdings)'s (LON:G4M) look very promising so lets take a look.
What is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Gear4music (Holdings):
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).
Thus, Gear4music (Holdings) has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Specialty Retail industry average of 10%.
Above you can see how the current ROCE for Gear4music (Holdings) compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Gear4music (Holdings) here for free.
So How Is Gear4music (Holdings)'s ROCE Trending?
Investors would be pleased with what's happening at Gear4music (Holdings). 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. So we're very much inspired by what we're seeing at Gear4music (Holdings) thanks to its ability to profitably reinvest capital.
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 can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. 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
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Gear4music (Holdings) has. And a remarkable 388% 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.
On a final note, we found 4 warning signs for Gear4music (Holdings) (1 doesn't sit too well with us) you should be aware of.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning 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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