Investors Could Be Concerned With Gestamp Automoción's (BME:GEST) Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Gestamp Automoción (BME:GEST) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding 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. To calculate this metric for Gestamp Automoción, this is the formula:

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

0.021 = €134m ÷ (€9.2b - €2.9b) (Based on the trailing twelve months to March 2021).

Thus, Gestamp Automoción has an ROCE of 2.1%. In absolute terms, that's a low return and it also under-performs the Auto Components industry average of 8.3%.

View our latest analysis for Gestamp Automoción

In the above chart we have measured Gestamp Automoción'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 Gestamp Automoción.

How Are Returns Trending?

On the surface, the trend of ROCE at Gestamp Automoción doesn't inspire confidence. Over the last five years, returns on capital have decreased to 2.1% from 10% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

In Conclusion...

From the above analysis, we find it rather worrisome that returns on capital and sales for Gestamp Automoción have fallen, meanwhile the business is employing more capital than it was five years ago. Investors haven't taken kindly to these developments, since the stock has declined 30% from where it was three years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One more thing to note, we've identified 1 warning sign with Gestamp Automoción and understanding this should be part of your investment process.

While Gestamp Automoción 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.

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This article by Simply Wall St is general in nature. 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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