To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. However, after investigating Ark Restaurants (NASDAQ:ARKR), we don't think it's current trends fit the mold of a multi-bagger.
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. The formula for this calculation on Ark Restaurants is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.042 = US$5.4m ÷ (US$162m - US$34m) (Based on the trailing twelve months to October 2021).
So, Ark Restaurants has an ROCE of 4.2%. Ultimately, that's a low return and it under-performs the Hospitality industry average of 9.0%.
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'd like to look at how Ark Restaurants has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Ark Restaurants, we didn't gain much confidence. Around five years ago the returns on capital were 15%, but since then they've fallen to 4.2%. 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.
What We Can Learn From Ark Restaurants' ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Ark Restaurants is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 16% over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.
If you want to know some of the risks facing Ark Restaurants we've found 3 warning signs (2 don't sit too well with us!) that you should be aware of before investing here.
While Ark Restaurants may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.