There are a few key trends to look for if we want to identify the next multi-bagger. 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. Although, when we looked at GUD Holdings (ASX:GUD), it didn't seem to tick all of these boxes.
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. The formula for this calculation on GUD Holdings is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = AU$98m ÷ (AU$819m - AU$133m) (Based on the trailing twelve months to June 2021).
Therefore, GUD Holdings has an ROCE of 14%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Auto Components industry average of 17%.
Above you can see how the current ROCE for GUD Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for GUD Holdings.
The Trend Of ROCE
When we looked at the ROCE trend at GUD Holdings, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 14% from 18% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
On a side note, GUD Holdings has done well to pay down its current liabilities to 16% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Bottom Line On GUD Holdings' ROCE
In summary, despite lower returns in the short term, we're encouraged to see that GUD Holdings is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 23% gain to shareholders who've held over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.
Like most companies, GUD Holdings does come with some risks, and we've found 4 warning signs that you should be aware of.
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. 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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