What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Abhotel (TYO:6565), it didn't seem to tick all of these boxes.
What is 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. Analysts use this formula to calculate it for Abhotel:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0082 = JP¥145m ÷ (JP¥21b - JP¥2.9b) (Based on the trailing twelve months to December 2020).
Thus, Abhotel has an ROCE of 0.8%. Ultimately, that's a low return and it under-performs the Hospitality industry average of 7.0%.
See our latest analysis for Abhotel
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'd like to look at how Abhotel has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at Abhotel doesn't inspire confidence. Around four years ago the returns on capital were 12%, but since then they've fallen to 0.8%. 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.
Our Take On Abhotel's ROCE
We're a bit apprehensive about Abhotel because despite more capital being deployed in the business, returns on that capital and sales have both fallen. It should come as no surprise then that the stock has fallen 54% over the last three years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
If you want to know some of the risks facing Abhotel we've found 4 warning signs (2 are a bit unpleasant!) that you should be aware of before investing here.
While Abhotel may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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 TSE:6565
Excellent balance sheet with acceptable track record.
