To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Gatekeeper Systems' (CVE:GSI) returns on capital, so let's have a look.
What is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Gatekeeper Systems is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.20 = CA$2.5m ÷ (CA$14m - CA$1.4m) (Based on the trailing twelve months to February 2021).
Thus, Gatekeeper Systems has an ROCE of 20%. That's a fantastic return and not only that, it outpaces the average of 11% earned by companies in a similar industry.
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'd like to look at how Gatekeeper Systems has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Can We Tell From Gatekeeper Systems' ROCE Trend?
The fact that Gatekeeper Systems is now generating some pre-tax profits from its prior investments is very encouraging. About five years ago the company was generating losses but things have turned around because it's now earning 20% on its capital. In addition to that, Gatekeeper Systems is employing 500% more capital than previously which is expected of a company that's trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
One more thing to note, Gatekeeper Systems has decreased current liabilities to 9.7% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. This tells us that Gatekeeper Systems has grown its returns without a reliance on increasing their current liabilities, which we're very happy with.
The Bottom Line On Gatekeeper Systems' ROCE
Long story short, we're delighted to see that Gatekeeper Systems' reinvestment activities have paid off and the company is now profitable. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. Therefore, we think it would be worth your time to check if these trends are going to continue.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Gatekeeper Systems (of which 1 is concerning!) that you should know about.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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