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What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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 when we looked at Hostelworld Group (LON:HSW) and its trend of ROCE, we really liked what we saw.
Understanding 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. To calculate this metric for Hostelworld Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = €11m ÷ (€91m - €23m) (Based on the trailing twelve months to June 2024).
Therefore, Hostelworld Group has an ROCE of 16%. In absolute terms, that's a satisfactory return, but compared to the Hospitality industry average of 7.5% it's much better.
View our latest analysis for Hostelworld Group
Above you can see how the current ROCE for Hostelworld Group 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 analyst report for Hostelworld Group .
The Trend Of ROCE
We're pretty happy with how the ROCE has been trending at Hostelworld Group. The data shows that returns on capital have increased by 210% over the trailing five years. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. Interestingly, the business may be becoming more efficient because it's applying 51% less capital than it was five years ago. Hostelworld Group may be selling some assets so it's worth investigating if the business has plans for future investments to increase returns further still.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 26% of its operations, which isn't ideal. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.
What We Can Learn From Hostelworld Group's ROCE
In the end, Hostelworld Group has proven it's capital allocation skills are good with those higher returns from less amount of capital. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 3.9% to shareholders. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.