If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Ergo, when we looked at the ROCE trends at Gamma Communications (LON:GAMA), we liked what we saw.
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 Gamma Communications:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.24 = UK£74m ÷ (UK£390m - UK£78m) (Based on the trailing twelve months to June 2022).
Therefore, Gamma Communications has an ROCE of 24%. In absolute terms that's a great return and it's even better than the Telecom industry average of 9.2%.
View our latest analysis for Gamma Communications
Above you can see how the current ROCE for Gamma Communications 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.
What The Trend Of ROCE Can Tell Us
Gamma Communications deserves to be commended in regards to it's returns. Over the past five years, ROCE has remained relatively flat at around 24% and the business has deployed 248% more capital into its operations. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.
On a side note, Gamma Communications has done well to reduce current liabilities to 20% of total assets over the last five years. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.
What We Can Learn From Gamma Communications' ROCE
Gamma Communications has demonstrated its proficiency by generating high returns on increasing amounts of capital employed, which we're thrilled about. And the stock has followed suit returning a meaningful 84% to shareholders over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.
Like most companies, Gamma Communications does come with some risks, and we've found 1 warning sign that you should be aware of.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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