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Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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 Colonial Motor (NZSE:CMO) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Return On Capital Employed (ROCE): What Is It?
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. To calculate this metric for Colonial Motor, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = NZ$54m ÷ (NZ$548m - NZ$186m) (Based on the trailing twelve months to June 2023).
So, Colonial Motor has an ROCE of 15%. By itself that's a normal return on capital and it's in line with the industry's average returns of 15%.
See our latest analysis for Colonial Motor
Historical performance is a great place to start when researching a stock so above you can see the gauge for Colonial Motor's ROCE against it's prior returns. If you'd like to look at how Colonial Motor has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Can We Tell From Colonial Motor's ROCE Trend?
When we looked at the ROCE trend at Colonial Motor, we didn't gain much confidence. To be more specific, ROCE has fallen from 20% over the last five years. However it looks like Colonial Motor 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.
On a side note, Colonial Motor has done well to pay down its current liabilities to 34% 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.
In Conclusion...
In summary, Colonial Motor is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has gained an impressive 47% over the last five years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.