Returns On Capital Are Showing Encouraging Signs At GDS Holdings (NASDAQ:GDS)

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we've noticed some promising trends at GDS Holdings (NASDAQ:GDS) so let's look a bit deeper.

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 GDS Holdings, this is the formula:

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

0.0092 = CN¥570m ÷ (CN¥74b - CN¥12b) (Based on the trailing twelve months to June 2022).

So, GDS Holdings has an ROCE of 0.9%. In absolute terms, that's a low return and it also under-performs the IT industry average of 12%.

Our analysis indicates that GDS is potentially overvalued!

In the above chart we have measured GDS Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering GDS Holdings here for free.

What The Trend Of ROCE Can Tell Us

We're glad to see that ROCE is heading in the right direction, even if it is still low at the moment. Over the last five years, returns on capital employed have risen substantially to 0.9%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 669%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

The Bottom Line

To sum it up, GDS Holdings has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And since the stock has fallen 33% over the last five years, there might be an opportunity here. With that in mind, we believe the promising trends warrant this stock for further investigation.

If you want to know some of the risks facing GDS Holdings we've found 2 warning signs (1 doesn't sit too well with us!) that you should be aware of before investing here.

While GDS Holdings 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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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.