To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at GCH Technology (SHSE:688625) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on GCH Technology is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = CN¥215m ÷ (CN¥3.0b - CN¥1.7b) (Based on the trailing twelve months to September 2023).
Thus, GCH Technology has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Chemicals industry average of 5.6% it's much better.
Check out our latest analysis for GCH Technology
Above you can see how the current ROCE for GCH Technology 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 report for GCH Technology.
What Can We Tell From GCH Technology's ROCE Trend?
We weren't thrilled with the trend because GCH Technology's ROCE has reduced by 49% over the last five years, while the business employed 557% more capital. Usually this isn't ideal, but given GCH Technology conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. It's unlikely that all of the funds raised have been put to work yet, so as a consequence GCH Technology might not have received a full period of earnings contribution from it.
On a side note, GCH Technology's current liabilities have increased over the last five years to 58% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.
Our Take On GCH Technology's ROCE
While returns have fallen for GCH Technology in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These growth trends haven't led to growth returns though, since the stock has fallen 41% over the last year. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.
On a final note, we found 2 warning signs for GCH Technology (1 makes us a bit uncomfortable) 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.