Will Loungers (LON:LGRS) Multiply In Value Going Forward?

If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. Having said that, from a first glance at Loungers (LON:LGRS) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Loungers, this is the formula:

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

0.027 = UK£6.9m ÷ (UK£306m - UK£46m) (Based on the trailing twelve months to October 2020).

Thus, Loungers has an ROCE of 2.7%. In absolute terms, that's a low return and it also under-performs the Hospitality industry average of 5.5%.

See our latest analysis for Loungers

In the above chart we have measured Loungers' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Loungers.

What The Trend Of ROCE Can Tell Us

We weren't thrilled with the trend because Loungers' ROCE has reduced by 75% over the last five years, while the business employed 1,080% more capital. Usually this isn't ideal, but given Loungers conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Loungers' earnings and if they change as a result from the capital raise.

On a related note, Loungers has decreased its current liabilities to 15% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line

We're a bit apprehensive about Loungers because despite more capital being deployed in the business, returns on that capital and sales have both fallen. However the stock has delivered a 8.9% return to shareholders over the last year, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Loungers does have some risks, we noticed 3 warning signs (and 1 which can't be ignored) we think you should 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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