To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at Gale Pacific (ASX:GAP) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Gale Pacific, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.068 = AU$8.3m ÷ (AU$170m - AU$48m) (Based on the trailing twelve months to December 2019).
So, Gale Pacific has an ROCE of 6.8%. In absolute terms, that's a low return and it also under-performs the Consumer Durables industry average of 16%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Gale Pacific has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Gale Pacific Tell Us?
In terms of Gale Pacific's historical ROCE trend, it doesn't exactly demand attention. The company has employed 35% more capital in the last five years, and the returns on that capital have remained stable at 6.8%. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 28% of total assets, is good to see from a business owner's perspective. Effectively suppliers now fund less of the business, which can lower some elements of risk.
The Bottom Line On Gale Pacific's ROCE
In conclusion, Gale Pacific has been investing more capital into the business, but returns on that capital haven't increased. And with the stock having returned a mere 29% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Gale Pacific (of which 1 is significant!) that you should know about.
While Gale Pacific isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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