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There Are Reasons To Feel Uneasy About Woolworths Group's (ASX:WOW) Returns On Capital

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Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Woolworths Group (ASX:WOW) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

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

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

0.14 = AU$3.5b ÷ (AU$39b - AU$13b) (Based on the trailing twelve months to January 2021).

So, Woolworths Group has an ROCE of 14%. By itself that's a normal return on capital and it's in line with the industry's average returns of 14%.

Check out our latest analysis for Woolworths Group

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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, you can check out the forecasts from the analysts covering Woolworths Group here for free.

What The Trend Of ROCE Can Tell Us

In terms of Woolworths Group's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 23% over the last five years. 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.

What We Can Learn From Woolworths Group's ROCE

Bringing it all together, while we're somewhat encouraged by Woolworths Group's reinvestment in its own business, we're aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 144% 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.

One more thing, we've spotted 2 warning signs facing Woolworths Group that you might find interesting.

While Woolworths Group isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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