There Are Reasons To Feel Uneasy About GreenTree Hospitality Group's (NYSE:GHG) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating GreenTree Hospitality Group (NYSE:GHG), we don't think it's current trends fit the mold of a multi-bagger.

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. Analysts use this formula to calculate it for GreenTree Hospitality Group:

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

0.11 = CN¥385m ÷ (CN¥4.5b - CN¥1.1b) (Based on the trailing twelve months to June 2021).

Therefore, GreenTree Hospitality Group has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 9.0% generated by the Hospitality industry.

View our latest analysis for GreenTree Hospitality Group

Above you can see how the current ROCE for GreenTree 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 to see what analysts are forecasting going forward, you should check out our free report for GreenTree Hospitality Group.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at GreenTree Hospitality Group, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 11% from 25% 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.

Our Take On GreenTree Hospitality Group'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 GreenTree Hospitality Group. And there could be an opportunity here if other metrics look good too, because the stock has declined 25% in the last three years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

If you want to know some of the risks facing GreenTree Hospitality Group we've found 2 warning signs (1 doesn't sit too well with us!) that you should be aware of before investing here.

While GreenTree 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.