There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. However, after briefly looking over the numbers, we don't think GHCL (NSE:GHCL) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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. The formula for this calculation on GHCL is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.19 = ₹6.5b ÷ (₹41b - ₹7.5b) (Based on the trailing twelve months to September 2021).
Thus, GHCL has an ROCE of 19%. That's a relatively normal return on capital, and it's around the 17% generated by the Chemicals industry.
Above you can see how the current ROCE for GHCL 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 GHCL here for free.
The Trend Of ROCE
On the surface, the trend of ROCE at GHCL doesn't inspire confidence. Around five years ago the returns on capital were 28%, but since then they've fallen to 19%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
On a related note, GHCL has decreased its current liabilities to 18% 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. 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.
Our Take On GHCL's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that GHCL is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 75% over the last five years, it would appear that investors are upbeat about the future. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
If you want to continue researching GHCL, you might be interested to know about the 1 warning sign that our analysis has discovered.
While GHCL isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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.