Yahoo Finance There Are Reasons To Feel Uneasy About Gear4music (Holdings)'s (LON:G4M) Returns On Capital
If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Gear4music (Holdings) (LON:G4M), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What Is It?
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 Gear4music (Holdings), this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.009 = UK£638k ÷ (UK£92m - UK£21m) (Based on the trailing twelve months to September 2023).
Thus, Gear4music (Holdings) has an ROCE of 0.9%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 14%.
Check out our latest analysis for Gear4music (Holdings)
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) for free.
So How Is Gear4music (Holdings)'s ROCE Trending?
In terms of Gear4music (Holdings)'s historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 5.8%, but since then they've fallen to 0.9%. However it looks like Gear4music (Holdings) might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
On a side note, Gear4music (Holdings) has done well to pay down its current liabilities to 23% of total assets. That could partly explain why the ROCE has dropped. 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 Key Takeaway
To conclude, we've found that Gear4music (Holdings) is reinvesting in the business, but returns have been falling. And investors appear hesitant that the trends will pick up because the stock has fallen 36% in the last five years. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Gear4music (Holdings) (of which 2 are potentially serious!) that you should know about.
While Gear4music (Holdings) may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list 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.
