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What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So, when we ran our eye over Coca-Cola's (NYSE:KO) trend of ROCE, we 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 Coca-Cola:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = US$12b ÷ (US$94b - US$19b) (Based on the trailing twelve months to April 2022).
Thus, Coca-Cola has an ROCE of 16%. In absolute terms, that's a satisfactory return, but compared to the Beverage industry average of 12% it's much better.
In the above chart we have measured Coca-Cola's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Coca-Cola.
So How Is Coca-Cola's ROCE Trending?
While the current returns on capital are decent, they haven't changed much. The company has consistently earned 16% for the last five years, and the capital employed within the business has risen 20% in that time. 16% is a pretty standard return, and it provides some comfort knowing that Coca-Cola has consistently earned this amount. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.
On a side note, Coca-Cola has done well to reduce current liabilities to 20% of total assets over the last five years. Effectively suppliers now fund less of the business, which can lower some elements of risk.
What We Can Learn From Coca-Cola's ROCE
The main thing to remember is that Coca-Cola has proven its ability to continually reinvest at respectable rates of return. Therefore it's no surprise that shareholders have earned a respectable 65% return if they held over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.
On a separate note, we've found 2 warning signs for Coca-Cola you'll probably want to know about.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.