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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Gentrack Group (NZSE:GTK) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
What is 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. To calculate this metric for Gentrack Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.024 = NZ$5.2m ÷ (NZ$244m - NZ$30m) (Based on the trailing twelve months to March 2020).
So, Gentrack Group has an ROCE of 2.4%. Ultimately, that's a low return and it under-performs the Software industry average of 11%.
Above you can see how the current ROCE for Gentrack Group 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 Gentrack Group.
What The Trend Of ROCE Can Tell Us
In terms of Gentrack Group's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 16% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. 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 Key Takeaway
Bringing it all together, while we're somewhat encouraged by Gentrack Group's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 16% over the last five years, investors may not be too optimistic on this trend improving either. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.
One more thing, we've spotted 2 warning signs facing Gentrack Group that you might find interesting.
While Gentrack Group isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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