Be Wary Of Gooch & Housego (LON:GHH) And Its Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Gooch & Housego (LON:GHH) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Gooch & Housego:

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

0.055 = UK£8.5m ÷ (UK£178m - UK£24m) (Based on the trailing twelve months to September 2020).

So, Gooch & Housego has an ROCE of 5.5%. Ultimately, that's a low return and it under-performs the Electronic industry average of 13%.

See our latest analysis for Gooch & Housego

In the above chart we have measured Gooch & Housego's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Gooch & Housego's ROCE Trend?

On the surface, the trend of ROCE at Gooch & Housego doesn't inspire confidence. To be more specific, ROCE has fallen from 12% over the last five years. However it looks like Gooch & Housego 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.

The Bottom Line

To conclude, we've found that Gooch & Housego is reinvesting in the business, but returns have been falling. Although the market must be expecting these trends to improve because the stock has gained 42% over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

If you'd like to know about the risks facing Gooch & Housego, we've discovered 1 warning sign that 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.

When trading Gooch & Housego or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.