If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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 Lordos Hotels (Holdings) (CSE:LHH), it didn't seem to tick all of these boxes.
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. The formula for this calculation on Lordos Hotels (Holdings) is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0054 = €637k ÷ (€121m - €3.8m) (Based on the trailing twelve months to June 2020).
Thus, Lordos Hotels (Holdings) has an ROCE of 0.5%. Even though it's in line with the industry average of 1.5%, it's still a low return by itself.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Lordos Hotels (Holdings), check out these free graphs here.
What Does the ROCE Trend For Lordos Hotels (Holdings) Tell Us?
In terms of Lordos Hotels (Holdings)'s historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 0.5% from 0.8% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
The Key Takeaway
We're a bit apprehensive about Lordos Hotels (Holdings) because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Yet despite these poor fundamentals, the stock has gained a huge 165% over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
If you want to continue researching Lordos Hotels (Holdings), you might be interested to know about the 3 warning signs that our analysis has discovered.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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