What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we’d want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. Looking at Papa John’s International (NASDAQ:PZZA), it does have a high ROCE right now, but lets see how returns are trending.
Return On Capital Employed (ROCE): What is it?
For those who don’t know, ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Papa John’s International:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.21 = US$132m ÷ (US$918m – US$292m) (Based on the trailing twelve months to March 2021).
So, Papa John’s International has an ROCE of 21%. In absolute terms that’s a great return and it’s even better than the Hospitality industry average of 5.0%.
Above you can see how the current ROCE for Papa John’s International 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 Papa John’s International here for free.
So How Is Papa John’s International’s ROCE Trending?
When we looked at the ROCE trend at Papa John’s International, we didn’t gain much confidence. To be more specific, while the ROCE is still high, it’s fallen from 37% where it was 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.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 32%, which has impacted the ROCE. If current liabilities hadn’t increased as much as they did, the ROCE could actually be even lower. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.
The Bottom Line On Papa John’s International’s ROCE
In summary, despite lower returns in the short term, we’re encouraged to see that Papa John’s International is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 65% over the last five years, it would appear that investors are upbeat about the future. So should these growth trends continue, we’d be optimistic on the stock going forward.
Papa John’s International does have some risks though, and we’ve spotted 2 warning signs for Papa John’s International that you might be interested in.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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