Should You Be Impressed By GMO AD Partners' (TYO:4784) Returns on Capital?

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at GMO AD Partners (TYO:4784) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for GMO AD Partners, this is the formula:

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

0.079 = JP¥488m ÷ (JP¥11b - JP¥5.2b) (Based on the trailing twelve months to September 2020).

Thus, GMO AD Partners has an ROCE of 7.9%. On its own, that's a low figure but it's around the 9.3% average generated by the Media industry.

See our latest analysis for GMO AD Partners

Historical performance is a great place to start when researching a stock so above you can see the gauge for GMO AD Partners' ROCE against it's prior returns. If you're interested in investigating GMO AD Partners' past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

In terms of GMO AD Partners' historical ROCE trend, it doesn't exactly demand attention. The company has consistently earned 7.9% for the last five years, and the capital employed within the business has risen 21% in that time. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.

Another thing to note, GMO AD Partners has a high ratio of current liabilities to total assets of 46%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On GMO AD Partners' ROCE

As we've seen above, GMO AD Partners' returns on capital haven't increased but it is reinvesting in the business. Since the stock has gained an impressive 56% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

On a final note, we've found 2 warning signs for GMO AD Partners that we think you should be aware of.

While GMO AD Partners may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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