Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. In light of that, when we looked at Colefax Group (LON:CFX) and its ROCE trend, we weren't exactly thrilled.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Colefax Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.057 = UK£3.0m ÷ (UK£72m - UK£20m) (Based on the trailing twelve months to October 2020).
So, Colefax Group has an ROCE of 5.7%. On its own, that's a low figure but it's around the 6.7% average generated by the Consumer Durables industry.
In the above chart we have measured Colefax Group'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 report on analyst forecasts for the company.
What The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at Colefax Group doesn't inspire confidence. Around five years ago the returns on capital were 20%, but since then they've fallen to 5.7%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
The Bottom Line On Colefax Group's ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for Colefax Group have fallen, meanwhile the business is employing more capital than it was five years ago. In spite of that, the stock has delivered a 1.9% return to shareholders who held over the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
Colefax Group does have some risks though, and we've spotted 2 warning signs for Colefax 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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Colefax Group PLC, together with its subsidiaries, engages in the design, marketing, distribution, and retailing of furnishing fabrics, wallpapers, trimmings, upholstered furniture, and related products in the United Kingdom, the United States, rest of Europe, and internationally.
Flawless balance sheet with outstanding track record.