Gear4music (Holdings) (LON:G4M) Could Become A Multi-Bagger

There are a few key trends to look for if we want to identify the next multi-bagger. 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. So when we looked at the ROCE trend of Gear4music (Holdings) (LON:G4M) we really liked what we saw.

What is 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. To calculate this metric for Gear4music (Holdings), this is the formula:

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

0.25 = UK£10m ÷ (UK£68m - UK£27m) (Based on the trailing twelve months to September 2020).

Thus, Gear4music (Holdings) has an ROCE of 25%. That's a fantastic return and not only that, it outpaces the average of 10% earned by companies in a similar industry.

Check out our latest analysis for Gear4music (Holdings)

Above you can see how the current ROCE for Gear4music (Holdings) compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Gear4music (Holdings).

What Can We Tell From Gear4music (Holdings)'s ROCE Trend?

Gear4music (Holdings) is displaying some positive trends. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 25%. Basically the business is earning more per dollar of capital invested and in addition to that, 351% more capital is being employed now too. So we're very much inspired by what we're seeing at Gear4music (Holdings) thanks to its ability to profitably reinvest capital.

Another thing to note, Gear4music (Holdings) has a high ratio of current liabilities to total assets of 40%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

To sum it up, Gear4music (Holdings) has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

If you'd like to know more about Gear4music (Holdings), we've spotted 2 warning signs, and 1 of them doesn't sit too well with us.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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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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