Why We Like The Returns At Gear4music (Holdings) (LON:G4M)

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. 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)?

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)

0.25 = 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 12% earned by companies in a similar industry.

See 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 The Trend Of ROCE Can Tell Us

The trends we've noticed at Gear4music (Holdings) are quite reassuring. The data shows that returns on capital have increased substantially over the last five years to 25%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 351%. So we're very much inspired by what we're seeing at Gear4music (Holdings) thanks to its ability to profitably reinvest capital.

On a separate but related note, it's important to know that Gear4music (Holdings) has a current liabilities to total assets ratio of 40%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

In Conclusion...

In summary, it's great to see that Gear4music (Holdings) can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Since the stock has returned a staggering 464% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

Gear4music (Holdings) does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is a bit concerning...

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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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