Capital Allocation Trends At Chorus (NZSE:CNU) Aren't Ideal

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Chorus (NZSE:CNU), 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 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. To calculate this metric for Chorus, this is the formula:

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

0.045 = NZ$239m ÷ (NZ$6.0b - NZ$705m) (Based on the trailing twelve months to December 2020).

Therefore, Chorus has an ROCE of 4.5%. In absolute terms, that's a low return but it's around the Telecom industry average of 5.4%.

Check out our latest analysis for Chorus

In the above chart we have measured Chorus' 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.

How Are Returns Trending?

We weren't thrilled with the trend because Chorus' ROCE has reduced by 39% over the last five years, while the business employed 71% more capital. Usually this isn't ideal, but given Chorus conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Chorus' earnings and if they change as a result from the capital raise. It's also worth noting the company's latest EBIT figure is within 10% of the previous year, so it's fair to assign the ROCE drop largely to the capital raise.

The Bottom Line

In summary, Chorus is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 112% 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.

On a separate note, we've found 2 warning signs for Chorus you'll probably want to know about.

While Chorus isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. 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.
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