Is Colonial Motor (NZSE:CMO) Likely To Turn Things Around?

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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. In light of that, when we looked at Colonial Motor (NZSE:CMO) and its ROCE trend, we weren't exactly thrilled.

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 Colonial Motor is:

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

0.15 = NZ$36m ÷ (NZ$381m - NZ$133m) (Based on the trailing twelve months to December 2020).

Thus, Colonial Motor has an ROCE of 15%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Specialty Retail industry average of 14%.

View our latest analysis for Colonial Motor

Historical performance is a great place to start when researching a stock so above you can see the gauge for Colonial Motor's ROCE against it's prior returns. If you'd like to look at how Colonial Motor has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at Colonial Motor, we didn't gain much confidence. Around five years ago the returns on capital were 19%, but since then they've fallen to 15%. 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'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 Bottom Line

To conclude, we've found that Colonial Motor is reinvesting in the business, but returns have been falling. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 127% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

One more thing, we've spotted 1 warning sign facing Colonial Motor that you might find interesting.

While Colonial Motor 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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