Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Hotel Chocolat Group (LON:HOTC) 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)
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 Hotel Chocolat Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = UK£12m ÷ (UK£156m - UK£52m) (Based on the trailing twelve months to June 2021).
So, Hotel Chocolat Group has an ROCE of 11%. That's a pretty standard return and it's in line with the industry average of 11%.
In the above chart we have measured Hotel Chocolat 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 Hotel Chocolat Group here for free.
What The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at Hotel Chocolat Group doesn't inspire confidence. Over the last five years, returns on capital have decreased to 11% from 30% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
The Bottom Line
In summary, despite lower returns in the short term, we're encouraged to see that Hotel Chocolat Group is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 81% over the last five years, it would appear that investors are upbeat about the future. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
On a final note, we found 2 warning signs for Hotel Chocolat Group (1 makes us a bit uncomfortable) you should be aware of.
While Hotel Chocolat Group isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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.