Coles Group (ASX:COL) Will Want To Turn Around Its Return Trends

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Coles Group (ASX:COL), it didn't seem to tick all of these boxes.

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 Coles Group, this is the formula:

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

0.14 = AU$1.8b ÷ (AU$19b - AU$6.4b) (Based on the trailing twelve months to June 2022).

Thus, Coles Group has an ROCE of 14%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Consumer Retailing industry average of 17%.

Check out the opportunities and risks within the AU Consumer Retailing industry.

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 report for Coles Group.

How Are Returns Trending?

In terms of Coles Group's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 22% over the last three years. However it looks like Coles Group might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Coles Group's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 21% over the last three years, which potentially indicates that investors are accounting for this going forward. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

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

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.

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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.