Returns On Capital At Gear4music (Holdings) (LON:G4M) Paint A Concerning Picture

If you're looking for a multi-bagger, there's a few things to keep an eye out 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Gear4music (Holdings) (LON:G4M), 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. 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)

0.045 = UK£3.4m ÷ (UK£96m - UK£20m) (Based on the trailing twelve months to September 2022).

Therefore, Gear4music (Holdings) has an ROCE of 4.5%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 13%.

View 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, you can check out the forecasts from the analysts covering Gear4music (Holdings) here for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Gear4music (Holdings) doesn't inspire confidence. To be more specific, ROCE has fallen from 7.8% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Gear4music (Holdings) has decreased its current liabilities to 21% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Key Takeaway

To conclude, we've found that Gear4music (Holdings) is reinvesting in the business, but returns have been falling. And investors may be expecting the fundamentals to get a lot worse because the stock has crashed 80% over the last five years. Therefore based on the analysis done in this article, we don't think Gear4music (Holdings) has the makings of a multi-bagger.

On a final note, we found 4 warning signs for Gear4music (Holdings) (2 are a bit unpleasant) you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.