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Nathan's Famous (NASDAQ:NATH) Could Be Struggling To Allocate Capital

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To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. So while Nathan's Famous (NASDAQ:NATH) has a high ROCE right now, lets see what we can decipher from how returns are changing.

Return On Capital Employed (ROCE): What is it?

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 Nathan's Famous is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.28 = US$28m ÷ (US$114m - US$15m) (Based on the trailing twelve months to June 2021).

So, Nathan's Famous has an ROCE of 28%. That's a fantastic return and not only that, it outpaces the average of 7.8% earned by companies in a similar industry.

See our latest analysis for Nathan's Famous

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Historical performance is a great place to start when researching a stock so above you can see the gauge for Nathan's Famous' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Nathan's Famous, check out these free graphs here.

How Are Returns Trending?

When we looked at the ROCE trend at Nathan's Famous, we didn't gain much confidence. Historically returns on capital were even higher at 42%, but they have dropped 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 Nathan's Famous' ROCE

Bringing it all together, while we're somewhat encouraged by Nathan's Famous' reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 33% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Nathan's Famous (of which 2 are significant!) that you should know about.

Nathan's Famous is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.