Cheesecake Factory (NASDAQ:CAKE) Might Be Having Difficulty Using Its Capital Effectively

Simply Wall St
January 12, 2022
Source: Shutterstock

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. Having said that, from a first glance at Cheesecake Factory (NASDAQ:CAKE) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Cheesecake Factory, this is the formula:

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

0.043 = US$94m ÷ (US$2.7b - US$557m) (Based on the trailing twelve months to September 2021).

Thus, Cheesecake Factory has an ROCE of 4.3%. In absolute terms, that's a low return and it also under-performs the Hospitality industry average of 9.0%.

See our latest analysis for Cheesecake Factory

NasdaqGS:CAKE Return on Capital Employed January 12th 2022

In the above chart we have measured Cheesecake Factory'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 Cheesecake Factory here for free.

What Does the ROCE Trend For Cheesecake Factory Tell Us?

On the surface, the trend of ROCE at Cheesecake Factory doesn't inspire confidence. To be more specific, ROCE has fallen from 21% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

What We Can Learn From Cheesecake Factory's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Cheesecake Factory. And there could be an opportunity here if other metrics look good too, because the stock has declined 30% in the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

On a final note, we've found 4 warning signs for Cheesecake Factory that we think you should be aware of.

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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