Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 investigating Shake Shack (NYSE:SHAK), we don't think it's current trends fit the mold of a multi-bagger.

What Is 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 Shake Shack is:

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

0.018 = US$26m ÷ (US$1.7b - US$176m) (Based on the trailing twelve months to September 2024).

Therefore, Shake Shack has an ROCE of 1.8%. In absolute terms, that's a low return and it also under-performs the Hospitality industry average of 9.1%.

In the above chart we have measured Shake Shack's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Shake Shack for free.

What Can We Tell From Shake Shack's ROCE Trend?

When we looked at the ROCE trend at Shake Shack, we didn't gain much confidence. Around five years ago the returns on capital were 3.8%, but since then they've fallen to 1.8%. 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.

The Bottom Line

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Shake Shack. And the stock has done incredibly well with a 116% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

One more thing to note, we've identified 1 warning sign with Shake Shack and understanding it should be part of your investment process.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.