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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. However, after investigating Arcos Dorados Holdings (NYSE:ARCO), we don't think it's current trends fit the mold of a multi-bagger.
Return On Capital Employed (ROCE): What is it?
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 Arcos Dorados Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.016 = US$25m ÷ (US$2.1b - US$592m) (Based on the trailing twelve months to June 2020).
Therefore, Arcos Dorados Holdings has an ROCE of 1.6%. Ultimately, that's a low return and it under-performs the Hospitality industry average of 5.4%.
In the above chart we have measured Arcos Dorados Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Arcos Dorados Holdings.
What The Trend Of ROCE Can Tell Us
In terms of Arcos Dorados Holdings' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 12%, but since then they've fallen to 1.6%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
The Bottom Line On Arcos Dorados Holdings' ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for Arcos Dorados Holdings have fallen, meanwhile the business is employing more capital than it was five years ago. Despite the concerning underlying trends, the stock has actually gained 35% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
One more thing, we've spotted 1 warning sign facing Arcos Dorados Holdings that you might find interesting.
While Arcos Dorados Holdings isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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