If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Hilton Grand Vacations (NYSE:HGV) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Understanding 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 Hilton Grand Vacations is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.02 = US$67m ÷ (US$3.5b - US$209m) (Based on the trailing twelve months to September 2020).
So, Hilton Grand Vacations has an ROCE of 2.0%. Ultimately, that's a low return and it under-performs the Hospitality industry average of 4.6%.
In the above chart we have measured Hilton Grand Vacations' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Hilton Grand Vacations here for free.
The Trend Of ROCE
When we looked at the ROCE trend at Hilton Grand Vacations, we didn't gain much confidence. Around five years ago the returns on capital were 21%, but since then they've fallen to 2.0%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
What We Can Learn From Hilton Grand Vacations' ROCE
In summary, we're somewhat concerned by Hilton Grand Vacations' diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last three years have experienced a 27% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
Hilton Grand Vacations does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those is a bit unpleasant...
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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