There Are Reasons To Feel Uneasy About Shake Shack's (NYSE:SHAK) Returns On Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. In light of that, when we looked at Shake Shack (NYSE:SHAK) and its ROCE trend, we weren't exactly thrilled.

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. To calculate this metric for Shake Shack, this is the formula:

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

0.014 = US$22m ÷ (US$1.7b - US$168m) (Based on the trailing twelve months to June 2024).

Therefore, Shake Shack has an ROCE of 1.4%. Ultimately, that's a low return and it under-performs the Hospitality industry average of 10%.

View our latest analysis for Shake Shack

In the above chart we have measured Shake Shack's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Shake Shack .

So How Is Shake Shack's ROCE Trending?

When we looked at the ROCE trend at Shake Shack, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 1.4% from 4.2% five years ago. 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.

Our Take On Shake Shack's ROCE

While returns have fallen for Shake Shack in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These trends are starting to be recognized by investors since the stock has delivered a 20% gain to shareholders who've held 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 could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation for SHAK on our platform quite valuable.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.