If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. Speaking of which, we noticed some great changes in Potbelly's (NASDAQ:PBPB) returns on capital, so let's have a look.

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. To calculate this metric for Potbelly, this is the formula:

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

0.078 = US$15m ÷ (US$259m - US$65m) (Based on the trailing twelve months to September 2024).

Thus, Potbelly has an ROCE of 7.8%. On its own, that's a low figure but it's around the 9.6% average generated by the Hospitality industry.

View our latest analysis for Potbelly

In the above chart we have measured Potbelly'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 analyst report for Potbelly .

So How Is Potbelly's ROCE Trending?

Like most people, we're pleased that Potbelly is now generating some pretax earnings. Historically the company was generating losses but as we can see from the latest figures referenced above, they're now earning 7.8% on their capital employed. Additionally, the business is utilizing 31% less capital than it was five years ago, and taken at face value, that can mean the company needs less funds at work to get a return. Potbelly could be selling under-performing assets since the ROCE is improving.

The Bottom Line

From what we've seen above, Potbelly has managed to increase it's returns on capital all the while reducing it's capital base. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

On a final note, we've found 2 warning signs for Potbelly that we think you should be aware of.

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.