There Are Reasons To Feel Uneasy About Cheesecake Factory's (NASDAQ:CAKE) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. In light of that, when we looked at Cheesecake Factory (NASDAQ:CAKE) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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)

0.041 = US$88m ÷ (US$2.7b - US$606m) (Based on the trailing twelve months to September 2022).

Thus, Cheesecake Factory has an ROCE of 4.1%. Ultimately, that's a low return and it under-performs the Hospitality industry average of 11%.

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'd like, you can check out the forecasts from the analysts covering Cheesecake Factory here for free.

The Trend Of ROCE

In terms of Cheesecake Factory's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 4.1% from 19% 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. If these investments prove successful, this can bode very well for long term stock performance.

In Conclusion...

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. These trends don't appear to have influenced returns though, because the total return from the stock has been mostly flat over 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.

Cheesecake Factory does have some risks though, and we've spotted 3 warning signs for Cheesecake Factory that you might be interested in.

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.