Returns On Capital Are Showing Encouraging Signs At GLG (ASX:GLE)

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So on that note, GLG (ASX:GLE) looks quite promising in regards to its trends of return on capital.

Return On Capital Employed (ROCE): What is it?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for GLG:

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

0.12 = US$8.8m ÷ (US$141m - US$65m) (Based on the trailing twelve months to December 2020).

Therefore, GLG has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Luxury industry average of 8.7% it's much better.

See our latest analysis for GLG

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 want to delve into the historical earnings, revenue and cash flow of GLG, check out these free graphs here.

What Does the ROCE Trend For GLG Tell Us?

Investors would be pleased with what's happening at GLG. Over the last five years, returns on capital employed have risen substantially to 12%. The amount of capital employed has increased too, by 31%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

On a separate but related note, it's important to know that GLG has a current liabilities to total assets ratio of 46%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

Our Take On GLG's ROCE

In summary, it's great to see that GLG can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And a remarkable 202% total return over the last year tells us that investors are expecting more good things to come in the future. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

GLG does have some risks, we noticed 5 warning signs (and 1 which is concerning) we think you should know about.

While GLG 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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