Here's What To Make Of Woolworths Group's (ASX:WOW) Returns On Capital
If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Woolworths Group (ASX:WOW) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Understanding Return On Capital Employed (ROCE)
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 Woolworths Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = AU$3.2b ÷ (AU$38b - AU$13b) (Based on the trailing twelve months to June 2020).
Thus, Woolworths Group has an ROCE of 13%. By itself that's a normal return on capital and it's in line with the industry's average returns of 13%.
See our latest analysis for Woolworths Group
Above you can see how the current ROCE for Woolworths Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Woolworths Group.
What Can We Tell From Woolworths Group's ROCE Trend?
In terms of Woolworths Group's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 13% from 25% five years ago. However it looks like Woolworths Group might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
What We Can Learn From Woolworths Group's ROCE
In summary, Woolworths Group 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 101% 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.
On a final note, we've found 4 warning signs for Woolworths Group that we think you should be aware of.
While Woolworths Group 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.
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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