Here's What To Make Of Chorus' (NZSE:CNU) Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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 Chorus (NZSE:CNU) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

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 Chorus:

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).

So, Chorus has an ROCE of 4.5%. On its own, that's a low figure but it's around the 5.4% average generated by the Telecom industry.

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'd like to see what analysts are forecasting going forward, you should check out our free report for Chorus.

What Does the ROCE Trend For Chorus Tell Us?

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. That being said, Chorus raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. Chorus probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt. 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.

What We Can Learn From Chorus' ROCE

To conclude, we've found that Chorus 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 167% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One more thing to note, we've identified 2 warning signs with Chorus and understanding these should be part of your investment process.

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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