If we want to find a stock that could multiply over the long term, what are the underlying trends we should look 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. Ultimately, this demonstrates that it’s a business that is reinvesting profits at increasing rates of return. That’s why when we briefly looked at Gamma Communications’ (LON:GAMA) ROCE trend, we were very happy with what we saw.
Return On Capital Employed (ROCE): What is it?
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. The formula for this calculation on Gamma Communications is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.23 = UK£63m ÷ (UK£346m – UK£79m) (Based on the trailing twelve months to June 2021).
Therefore, Gamma Communications has an ROCE of 24%. That’s a fantastic return and not only that, it outpaces the average of 8.9% earned by companies in a similar industry.
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’d like, you can check out the forecasts from the analysts covering Gamma Communications here for free.
How Are Returns Trending?
It’s hard not to be impressed by Gamma Communications’ returns on capital. The company has consistently earned 24% for the last five years, and the capital employed within the business has risen 259% in that time. With returns that high, it’s great that the business can continually reinvest its money at such appealing rates of return. If Gamma Communications can keep this up, we’d be very optimistic about its future.
The Bottom Line
In the end, the company has proven it can reinvest it’s capital at high rates of returns, which you’ll remember is a trait of a multi-bagger. On top of that, the stock has rewarded shareholders with a remarkable 254% return to those who’ve held 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.
On a final note, we’ve found 1 warning sign for Gamma Communications that we think 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.
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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.