Finding a business that has the potential to grow significantly isn’t easy, but it is possible if we take a look at a few key financial metrics. A common approach is to try to find a business with Return on capital employed (ROCE) which increases, in connection with growth amount capital employed. Put simply, these types of businesses are dialing machines, which means they continually reinvest their profits at ever higher rates of return. That said, from the first glance at Chorus (NZSE: CNU) We’re not jumping from our chairs on the yield trend, but taking a closer look.
Understanding Return on Capital Employed (ROCE)
For those who don’t know what ROCE is, it measures the amount of pre-tax profit a business can generate from the capital employed in its business. To calculate this metric for Chorus, here is the formula:
Return on capital employed = Profit before interest and taxes (EBIT) Ã· (Total assets – Current liabilities)
0.042 = NZ $ 226 million Ã· (NZ $ 5.9 billion – NZ $ 461 million) (Based on the last twelve months up to June 2021).
Thereby, Chorus has a ROCE of 4.2%. In absolute terms, this is a low return and it is also below the telecom industry average of 5.9%.
See our latest analysis for Chorus
In the chart above, we’ve measured Chorus’ past ROCE against its past performance, but the future is arguably more important. If you are interested, you can view analyst forecasts in our free analyst forecast report for the company.
What can we say about the ROCE trend of Chorus?
The evolution of ROCE does not look fantastic as it is down 7.2% five years ago, while the capital employed of the company increased by 46%. That being said, Chorus raised capital before the publication of its latest results, which could partly explain the increase in capital employed. Chorus has probably not yet received a full year of revenue from the new funds it has raised, so these numbers should be taken with a grain of salt.
The key to take away
In summary, while we are somewhat encouraged by Chorus’ reinvestment in its own business, we are aware that the returns are diminishing. Yet to long-term shareholders, the stock has offered them an incredible 129% return over the past five years, so the market seems bullish on its future. However, unless these underlying trends turn more positive, our hopes would not be too high.
One more thing to note, we have identified 2 warning signs with Chorus and understanding them should be part of your investment process.
While Chorus is not currently achieving the highest returns, we have compiled a list of companies that currently generate over 25% return on equity. Check it out free list here.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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