Coles Group (ASX:COL) Might Be Having Difficulty Using Its Capital Effectively

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Coles Group (ASX:COL) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Coles Group, this is the formula:

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

0.15 = AU$2.0b ÷ (AU$20b - AU$6.8b) (Based on the trailing twelve months to June 2024).

Thus, Coles Group has an ROCE of 15%. That's a relatively normal return on capital, and it's around the 13% generated by the Consumer Retailing industry.

See our latest analysis for Coles Group

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

What Can We Tell From Coles Group's ROCE Trend?

When we looked at the ROCE trend at Coles Group, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 15% from 22% five years ago. 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.

Our Take On Coles Group's ROCE

To conclude, we've found that Coles Group is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 48% 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.

Coles Group could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation for COL on our platform quite valuable.

While Coles Group may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list 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.