Ruth's Hospitality Group (NASDAQ:RUTH) Might Be Having Difficulty Using Its Capital Effectively

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Ruth's Hospitality Group (NASDAQ:RUTH) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What Is It?

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. Analysts use this formula to calculate it for Ruth's Hospitality Group:

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

0.14 = US$55m ÷ (US$514m - US$115m) (Based on the trailing twelve months to June 2022).

So, Ruth's Hospitality Group has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Hospitality industry average of 9.6% it's much better.

Our analysis indicates that RUTH is potentially undervalued!

Above you can see how the current ROCE for Ruth's Hospitality 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 Ruth's Hospitality Group here for free.

So How Is Ruth's Hospitality Group's ROCE Trending?

In terms of Ruth's Hospitality Group's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 37%, but since then they've fallen to 14%. 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 related note, Ruth's Hospitality Group has decreased its current liabilities to 22% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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 Bottom Line On Ruth's Hospitality Group's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Ruth's Hospitality Group is reinvesting for growth and has higher sales as a result. However, total returns to shareholders over the last five years have been flat, which could indicate these growth trends potentially aren't accounted for yet by investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

On a separate note, we've found 1 warning sign for Ruth's Hospitality Group you'll probably want to know about.

While Ruth's Hospitality 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.