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. So on that note, RAVE Restaurant Group (NASDAQ:RAVE) looks quite promising in regards to its trends of return on capital.
What is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on RAVE Restaurant Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.058 = US$598k ÷ (US$12m - US$2.2m) (Based on the trailing twelve months to March 2021).
Thus, RAVE Restaurant Group has an ROCE of 5.8%. On its own, that's a low figure but it's around the 5.0% average generated by the Hospitality industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for RAVE Restaurant Group's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of RAVE Restaurant Group, check out these free graphs here.
The Trend Of ROCE
Like most people, we're pleased that RAVE Restaurant Group is now generating some pretax earnings. The company was generating losses five years ago, but now it's turned around, earning 5.8% which is no doubt a relief for some early shareholders. Additionally, the business is utilizing 29% less capital than it was five years ago, and taken at face value, that can mean the company needs less funds at work to get a return. This could potentially mean that the company is selling some of its assets.
The Key Takeaway
In a nutshell, we're pleased to see that RAVE Restaurant Group has been able to generate higher returns from less capital. And since the stock has fallen 62% over the last five years, there might be an opportunity here. That being the case, research into the company's current valuation metrics and future prospects seems fitting.
One more thing: We've identified 4 warning signs with RAVE Restaurant Group (at least 2 which make us uncomfortable) , and understanding these would certainly be useful.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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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