Coles Group's (ASX:COL) Returns On Capital Not Reflecting Well On The Business

There are a few key trends to look for if we want to identify the next multi-bagger. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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. Although, when we looked at Coles Group (ASX:COL), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What is it?

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)

0.14 = AU$1.7b ÷ (AU$19b - AU$6.3b) (Based on the trailing twelve months to January 2022).

Therefore, Coles Group has an ROCE of 14%. By itself that's a normal return on capital and it's in line with the industry's average returns of 14%.

View our latest analysis for Coles Group

Above you can see how the current ROCE for Coles Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Coles Group.

So How Is Coles Group's ROCE Trending?

When we looked at the ROCE trend at Coles Group, we didn't gain much confidence. Over the last three years, returns on capital have decreased to 14% from 24% three 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.

On a side note, Coles Group has done well to pay down its current liabilities to 34% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Key Takeaway

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 53% over the last three 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 does have some risks though, and we've spotted 1 warning sign for Coles Group that you might be interested in.

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.

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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.