Did you know there are some financial metrics that can provide clues of a potential multi-bagger? In a perfect world, we’d like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it’s a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. That’s why when we briefly looked at G.A. Holdings’ (HKG:8126) ROCE trend, we were pretty happy with what we saw.
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. Analysts use this formula to calculate it for G.A. Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.12 = HK$91m ÷ (HK$1.5b – HK$788m) (Based on the trailing twelve months to June 2020).
Therefore, G.A. Holdings has an ROCE of 12%. In absolute terms, that’s a satisfactory return, but compared to the Retail Distributors industry average of 7.6% it’s much better.
Historical performance is a great place to start when researching a stock so above you can see the gauge for G.A. Holdings’ ROCE against it’s prior returns. If you’d like to look at how G.A. Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
While the current returns on capital are decent, they haven’t changed much. The company has employed 36% more capital in the last five years, and the returns on that capital have remained stable at 12%. 12% is a pretty standard return, and it provides some comfort knowing that G.A. Holdings has consistently earned this amount. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn’t increased to 51% of total assets, this reported ROCE would probably be less than12% because total capital employed would be higher.The 12% ROCE could be even lower if current liabilities weren’t 51% of total assets, because the the formula would show a larger base of total capital employed. Additionally, this high level of current liabilities isn’t ideal because it means the company’s suppliers (or short-term creditors) are effectively funding a large portion of the business.
The main thing to remember is that G.A. Holdings has proven its ability to continually reinvest at respectable rates of return. Yet over the last five years the stock has declined 63%, so the decline might provide an opening. That’s why we think it’d be worthwhile to look further into this stock given the fundamentals are appealing.
G.A. Holdings does come with some risks though, we found 4 warning signs in our investment analysis, and 2 of those make us uncomfortable…
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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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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