Capital Allocation Trends At Codan (ASX:CDA) Aren't Ideal

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. However, after investigating Codan (ASX:CDA), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What Is It?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Codan:

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

0.17 = AU$103m ÷ (AU$740m - AU$136m) (Based on the trailing twelve months to December 2023).

Thus, Codan has an ROCE of 17%. By itself that's a normal return on capital and it's in line with the industry's average returns of 17%.

Check out our latest analysis for Codan

In the above chart we have measured Codan's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Codan .

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Codan doesn't inspire confidence. To be more specific, ROCE has fallen from 31% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

The Bottom Line On Codan's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Codan. And the stock has done incredibly well with a 302% return over the last five years, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we'd be optimistic on the stock going forward.

If you're still interested in Codan it's worth checking out our FREE intrinsic value approximation for CDA to see if it's trading at an attractive price in other respects.

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.