There are a few key trends to look for if we want to identify the next multi-bagger. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Loungers (LON:LGRS) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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. Analysts use this formula to calculate it for Loungers:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.027 = UK£6.9m ÷ (UK£306m - UK£46m) (Based on the trailing twelve months to October 2020).
Thus, Loungers has an ROCE of 2.7%. Ultimately, that's a low return and it under-performs the Hospitality industry average of 5.5%.
See our latest analysis for Loungers
Above you can see how the current ROCE for Loungers compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Loungers here for free.
What Can We Tell From Loungers' ROCE Trend?
We weren't thrilled with the trend because Loungers' ROCE has reduced by 75% over the last five years, while the business employed 1,080% more capital. Usually this isn't ideal, but given Loungers conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. Loungers probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.
On a related note, Loungers has decreased its current liabilities to 15% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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
From the above analysis, we find it rather worrisome that returns on capital and sales for Loungers have fallen, meanwhile the business is employing more capital than it was five years ago. And long term shareholders have watched their investments stay flat over the last year. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.