Investors Could Be Concerned With Coles Group's (ASX:COL) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. 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. However, after investigating Coles Group (ASX:COL), we don't think it's current trends fit the mold of a multi-bagger.

Understanding 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. The formula for this calculation on Coles Group is:

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

0.14 = AU$1.8b ÷ (AU$19b - AU$6.3b) (Based on the trailing twelve months to January 2021).

So, Coles Group has an ROCE of 14%. That's a pretty standard return and it's in line with the industry average of 14%.

See 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, you can check out the forecasts from the analysts covering Coles Group here for free.

How Are Returns Trending?

In terms of Coles Group's historical ROCE movements, the trend isn't fantastic. Around two years ago the returns on capital were 24%, but since then they've fallen to 14%. 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'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 33% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line On Coles Group's ROCE

To conclude, we've found that Coles Group is reinvesting in the business, but returns have been falling. Additionally, the stock's total return to shareholders over the last year has been flat, which isn't too surprising. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

On a separate note, we've found 2 warning signs for Coles Group you'll probably want to know about.

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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