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Returns On Capital Signal Tricky Times Ahead For Gatekeeper Systems (CVE:GSI)

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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. However, after briefly looking over the numbers, we don't think Gatekeeper Systems (CVE:GSI) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. Analysts use this formula to calculate it for Gatekeeper Systems:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.14 = CA$1.8m ÷ (CA$14m - CA$1.2m) (Based on the trailing twelve months to May 2021).

Thus, Gatekeeper Systems has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Electronic industry average of 11% it's much better.

View our latest analysis for Gatekeeper Systems

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Historical performance is a great place to start when researching a stock so above you can see the gauge for Gatekeeper Systems' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Gatekeeper Systems, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

Unfortunately, the trend isn't great with ROCE falling from 28% five years ago, while capital employed has grown 417%. That being said, Gatekeeper Systems raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Gatekeeper Systems' earnings and if they change as a result from the capital raise.

On a related note, Gatekeeper Systems has decreased its current liabilities to 8.8% 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.

What We Can Learn From Gatekeeper Systems' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Gatekeeper Systems is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 195% return over the last five years, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we'd be optimistic on the stock going forward.

On a separate note, we've found 2 warning signs for Gatekeeper Systems you'll probably want to know about.

While Gatekeeper Systems 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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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