Investors Shouldn't Overlook The Favourable Returns On Capital At Gamma Communications (LON:GAMA)

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. That's why when we briefly looked at Gamma Communications' (LON:GAMA) ROCE trend, we were very happy with what we saw.

Return On Capital Employed (ROCE): What Is It?

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. The formula for this calculation on Gamma Communications is:

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

0.24 = UK£74m ÷ (UK£390m - UK£78m) (Based on the trailing twelve months to June 2022).

Thus, Gamma Communications has an ROCE of 24%. That's a fantastic return and not only that, it outpaces the average of 9.2% earned by companies in a similar industry.

Our analysis indicates that GAMA is potentially undervalued!

Above you can see how the current ROCE for Gamma Communications 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.

What Does the ROCE Trend For Gamma Communications Tell Us?

Gamma Communications deserves to be commended in regards to it's returns. The company has employed 248% more capital in the last five years, and the returns on that capital have remained stable at 24%. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.

On a side note, Gamma Communications has done well to reduce current liabilities to 20% of total assets over the last five years. Effectively suppliers now fund less of the business, which can lower some elements of risk.

Our Take On Gamma Communications' ROCE

In the end, the company has proven it can reinvest it's capital at high rates of returns, which you'll remember is a trait of a multi-bagger. Therefore it's no surprise that shareholders have earned a respectable 75% return if they held over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.

Gamma Communications does have some risks though, and we've spotted 1 warning sign for Gamma Communications that you might be interested in.

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. 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.