Shake Shack's (NYSE:SHAK) Returns On Capital Not Reflecting Well On The Business

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Shake Shack (NYSE:SHAK) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Shake Shack:

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

0.0026 = US$3.7m ÷ (US$1.6b - US$152m) (Based on the trailing twelve months to September 2023).

So, Shake Shack has an ROCE of 0.3%. Ultimately, that's a low return and it under-performs the Hospitality industry average of 9.6%.

See our latest analysis for Shake Shack

Above you can see how the current ROCE for Shake Shack compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Shake Shack's ROCE Trend?

When we looked at the ROCE trend at Shake Shack, we didn't gain much confidence. To be more specific, ROCE has fallen from 6.7% over the last five years. 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.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that Shake Shack is reinvesting for growth and has higher sales as a result. In light of this, the stock has only gained 11% over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

Shake Shack does have some risks though, and we've spotted 1 warning sign for Shake Shack that you might be interested in.

While Shake Shack 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.