Hostelworld Group (LON:HSW) May Have Issues Allocating Its Capital

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. Basically the company is earning less on its investments and it is also reducing its total assets. So after we looked into Hostelworld Group (LON:HSW), the trends above didn't look too great.

Understanding 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. To calculate this metric for Hostelworld Group, this is the formula:

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

0.01 = €633k ÷ (€96m - €33m) (Based on the trailing twelve months to June 2023).

So, Hostelworld Group has an ROCE of 1.0%. Ultimately, that's a low return and it under-performs the Hospitality industry average of 7.3%.

See our latest analysis for Hostelworld Group

In the above chart we have measured Hostelworld Group's 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 Hostelworld Group here for free.

What Does the ROCE Trend For Hostelworld Group Tell Us?

We are a bit anxious about the trends of ROCE at Hostelworld Group. The company used to generate 6.5% on its capital five years ago but it has since fallen noticeably. In addition to that, Hostelworld Group is now employing 55% less capital than it was five years ago. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 35%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 1.0%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

The Bottom Line On Hostelworld Group's ROCE

In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. Investors haven't taken kindly to these developments, since the stock has declined 22% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

If you want to continue researching Hostelworld Group, you might be interested to know about the 1 warning sign 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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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.