Returns On Capital Signal Difficult Times Ahead For Hostelworld Group (LON:HSW)

What underlying fundamental trends can indicate that a company might be in decline? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. Having said that, after a brief look, Hostelworld Group (LON:HSW) we aren't filled with optimism, but let's investigate further.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Hostelworld Group is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.01 = €633k ÷ (€96m - €33m) (Based on the trailing twelve months to June 2023).

Thus, Hostelworld Group has an ROCE of 1.0%. Ultimately, that's a low return and it under-performs the Hospitality industry average of 7.3%.

See our latest analysis for Hostelworld Group

In the above chart we have measured Hostelworld Group's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For Hostelworld Group Tell Us?

We are a bit anxious about the trends of ROCE at Hostelworld Group. Unfortunately, returns have declined substantially over the last five years to the 1.0% we see today. On top of that, the business is utilizing 55% less capital within its operations. The fact that both are shrinking is an indication that the business is going through some tough times. If these underlying trends continue, we wouldn't be too optimistic going forward.

On a side note, Hostelworld Group's current liabilities have increased over the last five years to 35% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

The Key Takeaway

In summary, it's unfortunate that Hostelworld Group is shrinking its capital base and also generating lower returns. Investors haven't taken kindly to these developments, since the stock has declined 25% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One more thing, we've spotted 1 warning sign facing Hostelworld Group that you might find interesting.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.