Gym Group (LON:GYM) Is Reinvesting At Lower Rates Of Return

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. However, after investigating Gym Group (LON:GYM), we don't think it's current trends fit the mold of a multi-bagger.

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. Analysts use this formula to calculate it for Gym Group:

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

0.0013 = UK£700k ÷ (UK£585m - UK£57m) (Based on the trailing twelve months to June 2022).

Thus, Gym Group has an ROCE of 0.1%. In absolute terms, that's a low return and it also under-performs the Hospitality industry average of 6.8%.

View our latest analysis for Gym Group

In the above chart we have measured Gym Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Gym Group here for free.

What Does the ROCE Trend For Gym Group Tell Us?

On the surface, the trend of ROCE at Gym Group doesn't inspire confidence. Around five years ago the returns on capital were 8.2%, but since then they've fallen to 0.1%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Gym Group has decreased its current liabilities to 9.7% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

In Conclusion...

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Gym Group. And there could be an opportunity here if other metrics look good too, because the stock has declined 52% in the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you're still interested in Gym Group it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.

While Gym Group 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. 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.