There Are Reasons To Feel Uneasy About Gear4music (Holdings)'s (LON:G4M) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. 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)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed 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)

0.02 = UK£1.3m ÷ (UK£85m - UK£19m) (Based on the trailing twelve months to March 2023).

So, Gear4music (Holdings) has an ROCE of 2.0%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 13%.

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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

SWOT Analysis for Gear4music (Holdings)

The Trend Of ROCE

On the surface, the trend of ROCE at Gear4music (Holdings) doesn't inspire confidence. Over the last five years, returns on capital have decreased to 2.0% from 7.8% five years ago. However it looks like Gear4music (Holdings) might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Gear4music (Holdings) has decreased its current liabilities to 22% 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...

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 84% over the last five years. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

On a final note, we've found 1 warning sign for Gear4music (Holdings) that we think you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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.