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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. With that in mind, the ROCE of Gamma Communications (LON:GAMA) looks attractive right now, so lets see what the trend of returns can tell us.
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. Analysts use this formula to calculate it for Gamma Communications:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.23 = UK£56m ÷ (UK£322m - UK£75m) (Based on the trailing twelve months to December 2020).
So, Gamma Communications has an ROCE of 23%. That's a fantastic return and not only that, it outpaces the average of 8.5% earned by companies in a similar industry.
Above you can see how the current ROCE for Gamma Communications compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
It's hard not to be impressed by Gamma Communications' returns on capital. The company has consistently earned 23% for the last five years, and the capital employed within the business has risen 260% in that time. Now considering ROCE is an attractive 23%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns. You'll see this when looking at well operated businesses or favorable business models.
What We Can Learn From Gamma Communications' ROCE
Gamma Communications has demonstrated its proficiency by generating high returns on increasing amounts of capital employed, which we're thrilled about. And long term investors would be thrilled with the 432% return they've received over the last five years. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.
Gamma Communications does have some risks though, and we've spotted 1 warning sign for Gamma Communications that you might be interested in.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
This article by Simply Wall St is general in nature. 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.
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