In This Article:
If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Although, when we looked at Gear4music (Holdings) (LON:G4M), it didn't seem to tick all of these boxes.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Gear4music (Holdings) is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.04 = UK£2.7m ÷ (UK£90m - UK£23m) (Based on the trailing twelve months to September 2024).
Thus, Gear4music (Holdings) has an ROCE of 4.0%. 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 Gear4music (Holdings)
In the above chart we have measured Gear4music (Holdings)'s 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 Gear4music (Holdings) for free.
The Trend Of ROCE
On the surface, the trend of ROCE at Gear4music (Holdings) doesn't inspire confidence. To be more specific, ROCE has fallen from 6.8% over the last five years. However it looks like Gear4music (Holdings) 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.
On a side note, Gear4music (Holdings) has done well to pay down its current liabilities to 26% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
The Key Takeaway
In summary, Gear4music (Holdings) is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Unsurprisingly then, the total return to shareholders over the last five years has been flat. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.