Gap's (NYSE:GAP) Returns Have Hit A Wall

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Gap (NYSE:GAP) 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)?

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. The formula for this calculation on Gap is:

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

0.13 = US$1.1b ÷ (US$12b - US$3.3b) (Based on the trailing twelve months to November 2024).

So, Gap has an ROCE of 13%. By itself that's a normal return on capital and it's in line with the industry's average returns of 13%.

Check out our latest analysis for Gap

Above you can see how the current ROCE for Gap 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 Gap for free.

What The Trend Of ROCE Can Tell Us

We're a bit concerned with the trends, because the business is applying 22% less capital than it was five years ago and returns on that capital have stayed flat. When a company effectively decreases its assets base, it's not usually a sign to be optimistic on that company. You could assume that if this continues, the business will be smaller in a few year time, so probably not a multi-bagger.

What We Can Learn From Gap's ROCE

In summary, Gap isn't reinvesting funds back into the business and returns aren't growing. Since the stock has gained an impressive 56% over the last five years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

If you'd like to know about the risks facing Gap, we've discovered 2 warning signs that you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.