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. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. So when we looked at GMS (NYSE:GMS) and its trend of ROCE, we really liked what we saw.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for GMS, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.13 = US$411m ÷ (US$3.9b - US$708m) (Based on the trailing twelve months to July 2024).

Thus, GMS has an ROCE of 13%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Trade Distributors industry average of 12%.

Check out our latest analysis for GMS

In the above chart we have measured GMS' 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 GMS for free.

So How Is GMS' ROCE Trending?

GMS is displaying some positive trends. The data shows that returns on capital have increased substantially over the last five years to 13%. Basically the business is earning more per dollar of capital invested and in addition to that, 66% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

The Key Takeaway

All in all, it's terrific to see that GMS is reaping the rewards from prior investments and is growing its capital base. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

On a separate note, we've found 1 warning sign for GMS you'll probably want to know about.

While GMS may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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