The Returns At Woolworths Group (ASX:WOW) Provide Us With Signs Of What's To Come

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. In light of that, when we looked at Woolworths Group (ASX:WOW) and its ROCE trend, we weren't exactly thrilled.

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 Woolworths Group, this is the formula:

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

0.13 = AU$3.2b ÷ (AU$38b - AU$13b) (Based on the trailing twelve months to June 2020).

So, Woolworths Group has an ROCE of 13%. That's a pretty standard return and it's in line with the industry average of 13%.

View our latest analysis for Woolworths Group

In the above chart we have measured Woolworths Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Woolworths Group here for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Woolworths Group doesn't inspire confidence. To be more specific, ROCE has fallen from 25% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

The Bottom Line On Woolworths Group's ROCE

Bringing it all together, while we're somewhat encouraged by Woolworths Group's reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 100% gain to shareholders who have held over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Woolworths Group does have some risks though, and we've spotted 4 warning signs for Woolworths Group that you might be interested in.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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