If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Hotel Chocolat Group (LON:HOTC), it didn't seem to tick all of these boxes.
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. To calculate this metric for Hotel Chocolat Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.038 = UK£3.9m ÷ (UK£143m - UK£38m) (Based on the trailing twelve months to June 2020).
Thus, Hotel Chocolat Group has an ROCE of 3.8%. In absolute terms, that's a low return and it also under-performs the Food industry average of 9.4%.
Above you can see how the current ROCE for Hotel Chocolat Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Hotel Chocolat Group here for free.
How Are Returns Trending?
Unfortunately, the trend isn't great with ROCE falling from 26% five years ago, while capital employed has grown 662%. That being said, Hotel Chocolat Group raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Hotel Chocolat Group's earnings and if they change as a result from the capital raise.
On a related note, Hotel Chocolat Group has decreased its current liabilities to 27% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Bottom Line On Hotel Chocolat Group's ROCE
Bringing it all together, while we're somewhat encouraged by Hotel Chocolat Group's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly then, the total return to shareholders over the last three years has been flat. Therefore based on the analysis done in this article, we don't think Hotel Chocolat Group has the makings of a multi-bagger.
If you want to continue researching Hotel Chocolat Group, you might be interested to know about the 1 warning sign that our analysis has discovered.
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.
This article by Simply Wall St is general in nature. 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.
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