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Today we’ll evaluate Coffee Holding Co., Inc. (NASDAQ:JVA) to determine whether it could have potential as an investment idea. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.
So, How Do We Calculate ROCE?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for Coffee Holding:
0.087 = US$2.4m ÷ (US$39m – US$11m) (Based on the trailing twelve months to October 2018.)
Therefore, Coffee Holding has an ROCE of 8.7%.
Does Coffee Holding Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. It appears that Coffee Holding’s ROCE is fairly close to the Food industry average of 8.8%. Setting aside the industry comparison for now, Coffee Holding’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
Coffee Holding has an ROCE of 8.7%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. That suggests the business has returned to profitability.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Coffee Holding.
Coffee Holding’s Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Coffee Holding has total liabilities of US$11m and total assets of US$39m. Therefore its current liabilities are equivalent to approximately 29% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From Coffee Holding’s ROCE
That said, Coffee Holding’s ROCE is mediocre, there may be more attractive investments around. Of course you might be able to find a better stock than Coffee Holding. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.