GEM (SZSE:002340) Might Be Having Difficulty Using Its Capital Effectively

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. However, after briefly looking over the numbers, we don't think GEM (SZSE:002340) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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)

0.05 = CN¥1.5b ÷ (CN¥48b - CN¥17b) (Based on the trailing twelve months to September 2023).

So, GEM has an ROCE of 5.0%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 6.5%.

Check out 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're interested, you can view the analysts predictions in our free analyst report for GEM .

What The Trend Of ROCE Can Tell Us

In terms of GEM's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 11% over the last five years. 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 may take some time before the company starts to see any change in earnings from these investments.

The Bottom Line On GEM's ROCE

To conclude, we've found that GEM is reinvesting in the business, but returns have been falling. Unsurprisingly, the stock has only gained 33% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

If you want to know some of the risks facing GEM we've found 3 warning signs (1 is a bit unpleasant!) that you should be aware of before investing here.

While GEM isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.