There are a few key trends to look for if we want to identify the next multi-bagger. 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. 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 investigating Denny's (NASDAQ:DENN), we don't think it's current trends fit the mold of a multi-bagger.
Understanding 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. The formula for this calculation on Denny's is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = US$40m ÷ (US$411m - US$90m) (Based on the trailing twelve months to September 2021).
Therefore, Denny's has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Hospitality industry average of 9.0% it's much better.
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, you can check out the forecasts from the analysts covering Denny's here for free.
What Can We Tell From Denny's' ROCE Trend?
When we looked at the ROCE trend at Denny's, we didn't gain much confidence. Around five years ago the returns on capital were 32%, but since then they've fallen to 12%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
In Conclusion...
While returns have fallen for Denny's in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These trends are starting to be recognized by investors since the stock has delivered a 24% gain to shareholders who've held over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.
One more thing: We've identified 3 warning signs with Denny's (at least 1 which makes us a bit uncomfortable) , and understanding these would certainly be useful.
While Denny's 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.
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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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