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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. And in light of that, the trends we're seeing at Gaming Realms' (LON:GMR) look very promising so lets take a look.
What Is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Gaming Realms:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.22 = UK£6.3m ÷ (UK£32m - UK£3.5m) (Based on the trailing twelve months to June 2024).
Therefore, Gaming Realms has an ROCE of 22%. In absolute terms that's a great return and it's even better than the Entertainment industry average of 12%.
See our latest analysis for Gaming Realms
Above you can see how the current ROCE for Gaming Realms 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 Gaming Realms for free.
So How Is Gaming Realms' ROCE Trending?
The fact that Gaming Realms is now generating some pre-tax profits from its prior investments is very encouraging. The company was generating losses five years ago, but now it's earning 22% which is a sight for sore eyes. In addition to that, Gaming Realms is employing 55% more capital than previously which is expected of a company that's trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
On a related note, the company's ratio of current liabilities to total assets has decreased to 11%, which basically reduces it's funding from the likes of short-term creditors or suppliers. So this improvement in ROCE has come from the business' underlying economics, which is great to see.
What We Can Learn From Gaming Realms' ROCE
In summary, it's great to see that Gaming Realms has managed to break into profitability and is continuing to reinvest in its business. And a remarkable 562% total return over the last five years tells us that investors are expecting more good things to come in the future. In light of that, we think it's worth looking further into this stock because if Gaming Realms can keep these trends up, it could have a bright future ahead.