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. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. Although, when we looked at Gap (NYSE:GPS), it didn't seem to tick all of these boxes.
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. Analysts use this formula to calculate it for Gap:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.077 = US$611m ÷ (US$11b - US$3.1b) (Based on the trailing twelve months to February 2024).
Thus, Gap has an ROCE of 7.7%. In absolute terms, that's a low return and it also under-performs the Specialty Retail industry average 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 to see what analysts are forecasting going forward, you should check out our free analyst report for Gap .
So How Is Gap's ROCE Trending?
On the surface, the trend of ROCE at Gap doesn't inspire confidence. Over the last five years, returns on capital have decreased to 7.7% from 24% five years ago. However it looks like Gap might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
The Bottom Line On Gap's ROCE
Bringing it all together, while we're somewhat encouraged by Gap's reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 34% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.
One more thing, we've spotted 1 warning sign facing Gap that you might find interesting.
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.
About NYSE:GAP
Outstanding track record and undervalued.
