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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. So when we looked at Coffee Holding (NASDAQ:JVA) and its trend of ROCE, we really liked what we saw.
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. Analysts use this formula to calculate it for Coffee Holding:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.017 = US$593k ÷ (US$39m - US$4.0m) (Based on the trailing twelve months to July 2020).
Thus, Coffee Holding has an ROCE of 1.7%. In absolute terms, that's a low return and it also under-performs the Food industry average of 8.0%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Coffee Holding's ROCE against it's prior returns. If you're interested in investigating Coffee Holding's past further, check out this free graph of past earnings, revenue and cash flow.
So How Is Coffee Holding's ROCE Trending?
We're delighted to see that Coffee Holding is reaping rewards from its investments and is now generating some pre-tax profits. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 1.7% on its capital. And unsurprisingly, like most companies trying to break into the black, Coffee Holding is utilizing 40% more capital than it was five years ago. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 10%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. This tells us that Coffee Holding has grown its returns without a reliance on increasing their current liabilities, which we're very happy with.
The Bottom Line On Coffee Holding's ROCE
Long story short, we're delighted to see that Coffee Holding's reinvestment activities have paid off and the company is now profitable. Since the total return from the stock has been almost flat over the last five years, there might be an opportunity here if the valuation looks good. That being the case, research into the company's current valuation metrics and future prospects seems fitting.
One more thing, we've spotted 3 warning signs facing Coffee Holding that you might find interesting.
While Coffee Holding 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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