To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Gatekeeper Systems (CVE:GSI) and its ROCE trend, we weren't exactly thrilled.
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. The formula for this calculation on Gatekeeper Systems is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = CA$1.8m ÷ (CA$14m - CA$1.2m) (Based on the trailing twelve months to May 2021).
So, Gatekeeper Systems has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Electronic industry average of 6.6% it's much better.
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 Gatekeeper Systems, check out these free graphs here.
What The Trend Of ROCE Can Tell Us
The trend of ROCE doesn't look fantastic because it's fallen from 28% five years ago, while the business's capital employed increased by 417%. Usually this isn't ideal, but given Gatekeeper Systems conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. Gatekeeper Systems probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.
On a related note, Gatekeeper Systems has decreased its current liabilities to 8.8% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
While returns have fallen for Gatekeeper Systems in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And long term investors must be optimistic going forward because the stock has returned a huge 176% to shareholders in the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.
If you want to continue researching Gatekeeper Systems, you might be interested to know about the 2 warning signs that our analysis has discovered.
While Gatekeeper Systems 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.
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.
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