If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. That's why when we briefly looked at GK Software's (ETR:GKS) ROCE trend, we were pretty happy with what we saw.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for GK Software:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = €16m ÷ (€155m - €47m) (Based on the trailing twelve months to June 2022).
Therefore, GK Software has an ROCE of 15%. That's a relatively normal return on capital, and it's around the 14% generated by the Software industry.
Our analysis indicates that GKS is potentially undervalued!
In the above chart we have measured GK Software'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 report for GK Software.
What The Trend Of ROCE Can Tell Us
While the returns on capital are good, they haven't moved much. The company has consistently earned 15% for the last five years, and the capital employed within the business has risen 119% in that time. Since 15% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.
The Bottom Line
The main thing to remember is that GK Software has proven its ability to continually reinvest at respectable rates of return. And given the stock has only risen 21% over the last five years, we'd suspect the market is beginning to recognize these trends. So to determine if GK Software is a multi-bagger going forward, we'd suggest digging deeper into the company's other fundamentals.
If you're still interested in GK Software it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.
While GK Software isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
New: Manage All Your Stock Portfolios in One Place
We've created the ultimate portfolio companion for stock investors, and it's free.
• Connect an unlimited number of Portfolios and see your total in one currency
• Be alerted to new Warning Signs or Risks via email or mobile
• Track the Fair Value of your stocks
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
About XTRA:GKS
Reasonable growth potential with adequate balance sheet.
