If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Greggs (LON:GRG) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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. The formula for this calculation on Greggs is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.028 = UK£15m ÷ (UK£811m - UK£281m) (Based on the trailing twelve months to June 2020).
So, Greggs has an ROCE of 2.8%. Ultimately, that's a low return and it under-performs the Hospitality industry average of 5.5%.
See our latest analysis for Greggs
In the above chart we have measured Greggs' 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 Greggs here for free.
So How Is Greggs' ROCE Trending?
In terms of Greggs' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 26% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. 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 Bottom Line On Greggs' ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for Greggs have fallen, meanwhile the business is employing more capital than it was five years ago. Since the stock has skyrocketed 112% over the last five years, it looks like investors have high expectations of the stock. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
One final note, you should learn about the 3 warning signs we've spotted with Greggs (including 1 which makes us a bit uncomfortable) .
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. 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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About LSE:GRG
Good value with adequate balance sheet and pays a dividend.
