Returns On Capital At Collins Foods (ASX:CKF) Paint A Concerning Picture

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. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Collins Foods (ASX:CKF) 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)?

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 Collins Foods is:

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

0.081 = AU$85m ÷ (AU$1.2b - AU$152m) (Based on the trailing twelve months to October 2020).

Thus, Collins Foods has an ROCE of 8.1%. On its own that's a low return on capital but it's in line with the industry's average returns of 7.7%.

See our latest analysis for Collins Foods

In the above chart we have measured Collins Foods' 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 Collins Foods here for free.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Collins Foods, we didn't gain much confidence. Around five years ago the returns on capital were 14%, but since then they've fallen to 8.1%. 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.

The Key Takeaway

In summary, Collins Foods is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Yet to long term shareholders the stock has gifted them an incredible 194% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

One more thing: We've identified 2 warning signs with Collins Foods (at least 1 which is a bit concerning) , and understanding them would certainly be useful.

While Collins Foods 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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