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There are a few key trends to look for if we want to identify the next multi-bagger. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Event Hospitality & Entertainment (ASX:EVT), it didn't seem to tick all of these boxes.
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 Event Hospitality & Entertainment, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0052 = AU$8.4m ÷ (AU$2.7b - AU$1.1b) (Based on the trailing twelve months to June 2020).
So, Event Hospitality & Entertainment has an ROCE of 0.5%. In absolute terms, that's a low return and it also under-performs the Entertainment industry average of 12%.
Above you can see how the current ROCE for Event Hospitality & Entertainment 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 Event Hospitality & Entertainment.
The Trend Of ROCE
When we looked at the ROCE trend at Event Hospitality & Entertainment, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 0.5% from 14% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 40%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.
From the above analysis, we find it rather worrisome that returns on capital and sales for Event Hospitality & Entertainment have fallen, meanwhile the business is employing more capital than it was five years ago. It should come as no surprise then that the stock has fallen 15% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
One final note, you should learn about the 2 warning signs we've spotted with Event Hospitality & Entertainment (including 1 which is is significant) .
While Event Hospitality & Entertainment 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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