GWA Group's (ASX:GWA) Returns On Capital Not Reflecting Well On The Business

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. In light of that, when we looked at GWA Group (ASX:GWA) and its ROCE trend, we weren't exactly thrilled.

Understanding 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. The formula for this calculation on GWA Group is:

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

0.13 = AU$73m ÷ (AU$668m - AU$120m) (Based on the trailing twelve months to December 2023).

Thus, GWA Group has an ROCE of 13%. On its own, that's a standard return, however it's much better than the 11% generated by the Building industry.

View our latest analysis for GWA Group

Above you can see how the current ROCE for GWA Group 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 GWA Group for free.

How Are Returns Trending?

When we looked at the ROCE trend at GWA Group, we didn't gain much confidence. Around five years ago the returns on capital were 19%, but since then they've fallen to 13%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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.

Our Take On GWA Group's ROCE

Bringing it all together, while we're somewhat encouraged by GWA Group's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly then, the total return to shareholders over the last five years has been flat. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

Like most companies, GWA Group does come with some risks, and we've found 1 warning sign that you should be aware of.

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. 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@simplywallst.com