If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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 Hotel Chocolat Group (LON:HOTC), it didn't seem to tick all of these boxes.
Understanding 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 Hotel Chocolat Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = UK£20m ÷ (UK£238m - UK£75m) (Based on the trailing twelve months to December 2021).
Thus, Hotel Chocolat Group has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 10% generated by the Food industry.
View our latest analysis for Hotel Chocolat Group
Above you can see how the current ROCE for Hotel Chocolat 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 report for Hotel Chocolat Group.
What The Trend Of ROCE Can Tell Us
In terms of Hotel Chocolat Group's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 12% from 28% five years ago. 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.
On a side note, Hotel Chocolat Group has done well to pay down its current liabilities to 31% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
The Bottom Line On Hotel Chocolat Group's ROCE
While returns have fallen for Hotel Chocolat Group in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And there could be an opportunity here if other metrics look good too, because the stock has declined 23% in the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.