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. 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 GDS Holdings (NASDAQ:GDS), it didn't seem to tick all of these boxes.
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 GDS Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0095 = CN¥619m ÷ (CN¥76b - CN¥11b) (Based on the trailing twelve months to March 2024).
Thus, GDS Holdings has an ROCE of 1.0%. In absolute terms, that's a low return and it also under-performs the IT industry average of 11%.
In the above chart we have measured GDS Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for GDS Holdings .
What The Trend Of ROCE Can Tell Us
In terms of GDS Holdings' historical ROCE trend, it doesn't exactly demand attention. The company has consistently earned 1.0% for the last five years, and the capital employed within the business has risen 183% in that time. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
What We Can Learn From GDS Holdings' ROCE
As we've seen above, GDS Holdings' returns on capital haven't increased but it is reinvesting in the business. And investors may be expecting the fundamentals to get a lot worse because the stock has crashed 72% over the last five years. Therefore based on the analysis done in this article, we don't think GDS Holdings has the makings of a multi-bagger.
On a separate note, we've found 2 warning signs for GDS Holdings you'll probably want to know about.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.