What Do The Returns On Capital At CAG Group (STO:CAG) Tell Us?

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. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at CAG Group (STO:CAG) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What is it?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for CAG Group, this is the formula:

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

0.17 = kr43m ÷ (kr365m - kr119m) (Based on the trailing twelve months to September 2020).

Thus, CAG Group has an ROCE of 17%. In absolute terms, that's a pretty normal return, and it's somewhat close to the IT industry average of 19%.

Check out our latest analysis for CAG Group

In the above chart we have measured CAG Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering CAG Group here for free.

So How Is CAG Group's ROCE Trending?

On the surface, the trend of ROCE at CAG Group doesn't inspire confidence. Around four years ago the returns on capital were 30%, but since then they've fallen to 17%. 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 may take some time before the company starts to see any change in earnings from these investments.

On a side note, CAG Group has done well to pay down its current liabilities to 33% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

To conclude, we've found that CAG Group is reinvesting in the business, but returns have been falling. Although the market must be expecting these trends to improve because the stock has gained 17% over the last year. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

CAG Group does have some risks though, and we've spotted 2 warning signs for CAG Group that you might be interested in.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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