Cheesecake Factory (NASDAQ:CAKE) Is Reinvesting At Lower Rates Of Return

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. In light of that, when we looked at Cheesecake Factory (NASDAQ:CAKE) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Cheesecake Factory is:

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

0.052 = US$111m ÷ (US$2.8b - US$623m) (Based on the trailing twelve months to July 2023).

Thus, Cheesecake Factory has an ROCE of 5.2%. In absolute terms, that's a low return and it also under-performs the Hospitality industry average of 9.6%.

View our latest analysis for Cheesecake Factory

Above you can see how the current ROCE for Cheesecake Factory compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For Cheesecake Factory Tell Us?

In terms of Cheesecake Factory's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 14%, but since then they've fallen to 5.2%. However it looks like Cheesecake Factory might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

What We Can Learn From Cheesecake Factory's ROCE

Bringing it all together, while we're somewhat encouraged by Cheesecake Factory's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 37% over the last five years, investors may not be too optimistic on this trend improving either. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

One more thing, we've spotted 3 warning signs facing Cheesecake Factory that you might find interesting.

While Cheesecake Factory 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. 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.