If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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 briefly looking over the numbers, we don't think Denny's (NASDAQ:DENN) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Return On Capital Employed (ROCE): What is it?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Denny's, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.075 = US$25m ÷ (US$418m - US$88m) (Based on the trailing twelve months to June 2021).
Thus, Denny's has an ROCE of 7.5%. On its own that's a low return on capital but it's in line with the industry's average returns of 7.5%.
In the above chart we have measured Denny's' 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 Denny's.
What Does the ROCE Trend For Denny's Tell Us?
In terms of Denny's' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 7.5% from 32% five years ago. However it looks like Denny's might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
The Bottom Line
Bringing it all together, while we're somewhat encouraged by Denny's' reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 33% over the last five years, which potentially indicates that investors are accounting for this going forward. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.
On a final note, we've found 4 warning signs for Denny's that we think you should be aware of.
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.
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.
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