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. However, after briefly looking over the numbers, we don’t think Redcape Hotel Group (ASX:RDC) has the makings of a multi-bagger going forward, but let’s have a look at why that may be.
What is 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 Redcape Hotel Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.036 = AU$41m ÷ (AU$1.2b – AU$39m) (Based on the trailing twelve months to June 2020).
So, Redcape Hotel Group has an ROCE of 3.6%. Ultimately, that’s a low return and it under-performs the Hospitality industry average of 7.7%.
In the above chart we have measured Redcape Hotel Group’s 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 report on analyst forecasts for the company.
How Are Returns Trending?
There are better returns on capital out there than what we’re seeing at Redcape Hotel Group. Over the past two years, ROCE has remained relatively flat at around 3.6% and the business has deployed 218% more capital into its operations. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don’t provide a high return on capital.
Our Take On Redcape Hotel Group’s ROCE
In summary, Redcape Hotel Group has simply been reinvesting capital and generating the same low rate of return as before. And investors appear hesitant that the trends will pick up because the stock has fallen 13% in the last year. On the whole, we aren’t too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.
Since virtually every company faces some risks, it’s worth knowing what they are, and we’ve spotted 3 warning signs for Redcape Hotel Group (of which 2 don’t sit too well with us!) that you should know about.
While Redcape Hotel Group 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.
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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