Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. Having said that, from a first glance at General Motors (NYSE:GM) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
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. The formula for this calculation on General Motors is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.055 = US$8.6b ÷ (US$235b - US$80b) (Based on the trailing twelve months to December 2020).
Thus, General Motors has an ROCE of 5.5%. In absolute terms, that's a low return and it also under-performs the Auto industry average of 8.8%.
Above you can see how the current ROCE for General Motors 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 General Motors.
What Does the ROCE Trend For General Motors Tell Us?
In terms of General Motors' historical ROCE trend, it doesn't exactly demand attention. The company has consistently earned 5.5% for the last five years, and the capital employed within the business has risen 26% 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.
What We Can Learn From General Motors' ROCE
Long story short, while General Motors has been reinvesting its capital, the returns that it's generating haven't increased. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 145% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
General Motors does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is significant...
While General Motors 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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