Be Wary Of City Lodge Hotels (JSE:CLH) And Its Returns On Capital

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. So after we looked into City Lodge Hotels (JSE:CLH), the trends above didn't look too great.

Understanding 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. To calculate this metric for City Lodge Hotels, this is the formula:

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

0.097 = R267m ÷ (R3.0b - R298m) (Based on the trailing twelve months to December 2022).

So, City Lodge Hotels has an ROCE of 9.7%. In absolute terms, that's a low return and it also under-performs the Hospitality industry average of 22%.

Check out our latest analysis for City Lodge Hotels

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating City Lodge Hotels' past further, check out this free graph of past earnings, revenue and cash flow.

SWOT Analysis for City Lodge Hotels

So How Is City Lodge Hotels' ROCE Trending?

We are a bit worried about the trend of returns on capital at City Lodge Hotels. About five years ago, returns on capital were 21%, however they're now substantially lower than that as we saw above. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on City Lodge Hotels becoming one if things continue as they have.

What We Can Learn From City Lodge Hotels' ROCE

In summary, it's unfortunate that City Lodge Hotels is generating lower returns from the same amount of capital. Unsurprisingly then, the stock has dived 84% over the last five years, so investors are recognizing these changes and don't like the company's prospects. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

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

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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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.