The Returns On Capital At GEM (SZSE:002340) Don't Inspire Confidence

If you're looking for a multi-bagger, there's a few things to 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. 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 GEM (SZSE:002340) and its ROCE trend, we weren't exactly thrilled.

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Return On Capital Employed (ROCE): What Is It?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for GEM, this is the formula:

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

0.034 = CN¥1.1b ÷ (CN¥62b - CN¥28b) (Based on the trailing twelve months to September 2024).

Thus, GEM has an ROCE of 3.4%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 5.9%.

View our latest analysis for GEM

In the above chart we have measured GEM's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for GEM .

What Can We Tell From GEM's ROCE Trend?

When we looked at the ROCE trend at GEM, we didn't gain much confidence. Around five years ago the returns on capital were 11%, but since then they've fallen to 3.4%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a separate but related note, it's important to know that GEM has a current liabilities to total assets ratio of 46%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

Our Take On GEM'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 GEM. Furthermore the stock has climbed 46% over the last five years, it would appear that investors are upbeat about the future. 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 3 warning signs with GEM (at least 2 which don't sit too well with us) , and understanding these would certainly be useful.

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.