If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Huazhu Group (NASDAQ:HTHT), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What is it?
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 Huazhu Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.00001 = CN¥1.0m ÷ (CN¥64b - CN¥9.4b) (Based on the trailing twelve months to September 2021).
Therefore, Huazhu Group has an ROCE of 0.001%. Ultimately, that's a low return and it under-performs the Hospitality industry average of 9.2%.
Above you can see how the current ROCE for Huazhu Group 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 Huazhu Group here for free.
How Are Returns Trending?
On the surface, the trend of ROCE at Huazhu Group doesn't inspire confidence. To be more specific, ROCE has fallen from 12% 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
On a side note, Huazhu Group has done well to pay down its current liabilities to 15% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
The Key Takeaway
In summary, despite lower returns in the short term, we're encouraged to see that Huazhu Group is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 117% return over the last five years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
Huazhu Group does have some risks though, and we've spotted 2 warning signs for Huazhu Group that you might be interested in.
While Huazhu 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.
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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.