Yahoo Finance There Are Reasons To Feel Uneasy About Gap's (NYSE:GPS) Returns On Capital
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. 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. Although, when we looked at Gap (NYSE:GPS), it didn't seem to tick all of these boxes.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Gap:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.085 = US$855m ÷ (US$14b - US$3.7b) (Based on the trailing twelve months to July 2021).
Therefore, Gap has an ROCE of 8.5%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 18%.
View our latest analysis for Gap
Above you can see how the current ROCE for Gap 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.
The Trend Of ROCE
On the surface, the trend of ROCE at Gap doesn't inspire confidence. To be more specific, ROCE has fallen from 30% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
In Conclusion...
In summary, despite lower returns in the short term, we're encouraged to see that Gap is reinvesting for growth and has higher sales as a result. These trends don't appear to have influenced returns though, because the total return from the stock has been mostly flat over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.
If you'd like to know about the risks facing Gap, we've discovered 3 warning signs that you should be aware of.
While Gap isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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.
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