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Papa John's International (NASDAQ:PZZA) Could Be Struggling To Allocate Capital

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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at Papa John's International (NASDAQ:PZZA), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

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. 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)

0.28 = US$161m ÷ (US$830m - US$264m) (Based on the trailing twelve months to September 2022).

Thus, Papa John's International has an ROCE of 28%. That's a fantastic return and not only that, it outpaces the average of 11% earned by companies in a similar industry.

View our latest analysis for Papa John's International

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In the above chart we have measured Papa John's International's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Papa John's International.

What Does the ROCE Trend For Papa John's International Tell Us?

When we looked at the ROCE trend at Papa John's International, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 38%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

What We Can Learn From Papa John's International's ROCE

Bringing it all together, while we're somewhat encouraged by Papa John's International's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 50% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Papa John's International does have some risks, we noticed 3 warning signs (and 2 which can't be ignored) we think you should know about.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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.

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