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To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Having said that, from a first glance at Texas Roadhouse (NASDAQ:TXRH) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What is Return On Capital Employed (ROCE)?
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 Texas Roadhouse, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.048 = US$91m ÷ (US$2.4b - US$508m) (Based on the trailing twelve months to March 2021).
So, Texas Roadhouse has an ROCE of 4.8%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.0%.
Above you can see how the current ROCE for Texas Roadhouse compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Texas Roadhouse.
What Can We Tell From Texas Roadhouse's ROCE Trend?
On the surface, the trend of ROCE at Texas Roadhouse doesn't inspire confidence. To be more specific, ROCE has fallen from 19% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.
What We Can Learn From Texas Roadhouse's ROCE
Bringing it all together, while we're somewhat encouraged by Texas Roadhouse's reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 121% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
Texas Roadhouse does have some risks though, and we've spotted 3 warning signs for Texas Roadhouse that you might be interested in.
While Texas Roadhouse 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.
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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