Collins Foods (ASX:CKF) Might Be Having Difficulty Using Its Capital Effectively
What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Although, when we looked at Collins Foods (ASX:CKF), it didn't seem to tick all of these boxes.
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. Analysts use this formula to calculate it for Collins Foods:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.081 = AU$85m ÷ (AU$1.2b - AU$152m) (Based on the trailing twelve months to October 2020).
Thus, Collins Foods has an ROCE of 8.1%. Even though it's in line with the industry average of 7.7%, it's still a low return by itself.
View our latest analysis for Collins Foods
Above you can see how the current ROCE for Collins Foods compares to its prior returns on capital, but there's only so much you can tell from the past. 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
When we looked at the ROCE trend at Collins Foods, we didn't gain much confidence. Around five years ago the returns on capital were 14%, but since then they've fallen to 8.1%. 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 Key Takeaway
In summary, Collins Foods is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Yet to long term shareholders the stock has gifted them an incredible 204% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Collins Foods (of which 1 can't be ignored!) that you should know about.
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.
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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