If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at GreenTree Hospitality Group (NYSE:GHG), it didn't seem to tick all of these boxes.
What is Return On Capital Employed (ROCE)?
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 GreenTree Hospitality Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.093 = CN¥324m ÷ (CN¥4.5b - CN¥1.0b) (Based on the trailing twelve months to September 2021).
So, GreenTree Hospitality Group has an ROCE of 9.3%. Even though it's in line with the industry average of 9.0%, it's still a low return by itself.
In the above chart we have measured GreenTree Hospitality Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering GreenTree Hospitality Group here for free.
So How Is GreenTree Hospitality Group's ROCE Trending?
In terms of GreenTree Hospitality Group's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 9.3% from 24% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
The Bottom Line On GreenTree Hospitality Group's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that GreenTree Hospitality Group is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 51% in the last three years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.
GreenTree Hospitality Group does have some risks, we noticed 3 warning signs (and 1 which is a bit unpleasant) we think you should know about.
While GreenTree Hospitality Group isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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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