Ghitha Holding PJSC (ADX:GHITHA) Could Be Struggling To Allocate 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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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 investigating Ghitha Holding PJSC (ADX:GHITHA), we don't think it's current trends fit the mold of a multi-bagger.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Ghitha Holding PJSC, this is the formula:

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

0.10 = د.إ25m ÷ (د.إ401m - د.إ161m) (Based on the trailing twelve months to September 2021).

So, Ghitha Holding PJSC has an ROCE of 10%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Consumer Retailing industry average of 8.7%.

Check out our latest analysis for Ghitha Holding PJSC

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're interested in investigating Ghitha Holding PJSC's past further, check out this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

When we looked at the ROCE trend at Ghitha Holding PJSC, we didn't gain much confidence. Around three years ago the returns on capital were 14%, but since then they've fallen to 10%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Ghitha Holding PJSC's current liabilities have increased over the last three years to 40% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

Our Take On Ghitha Holding PJSC's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Ghitha Holding PJSC. And the stock has done incredibly well with a 164% return over the last year, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

One more thing: We've identified 2 warning signs with Ghitha Holding PJSC (at least 1 which makes us a bit uncomfortable) , and understanding them would certainly be useful.

While Ghitha Holding PJSC isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.