What financial metrics can indicate to us that a company is maturing or even in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. Having said that, after a brief look, Extended Stay America (NASDAQ:STAY) we aren't filled with optimism, but let's investigate further.
What is 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 Extended Stay America is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.059 = US$222m ÷ (US$4.3b - US$598m) (Based on the trailing twelve months to June 2020).
Thus, Extended Stay America has an ROCE of 5.9%. In absolute terms, that's a low return but it's around the Hospitality industry average of 5.4%.
Above you can see how the current ROCE for Extended Stay America compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Extended Stay America.
What Can We Tell From Extended Stay America's ROCE Trend?
In terms of Extended Stay America's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 8.6% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Extended Stay America to turn into a multi-bagger.
The Bottom Line
In summary, it's unfortunate that Extended Stay America is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 18% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Extended Stay America (of which 1 is potentially serious!) that you should know about.
While Extended Stay America 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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