Today we'll look at Coffee Holding Co., Inc. (NASDAQ:JVA) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from 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'.
How Do You Calculate Return On Capital Employed?
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:
0.043 = US$1.2m ÷ (US$38m - US$9.5m) (Based on the trailing twelve months to July 2019.)
Therefore, Coffee Holding has an ROCE of 4.3%.
Is Coffee Holding's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see Coffee Holding's ROCE is meaningfully below the Food industry average of 8.6%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside Coffee Holding's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.
Coffee Holding's current ROCE of 4.3% is lower than 3 years ago, when the company reported a 17% ROCE. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Coffee Holding's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during 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.
Do Coffee Holding's Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.
Coffee Holding has total liabilities of US$9.5m and total assets of US$38m. As a result, its current liabilities are equal to approximately 25% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
The Bottom Line On Coffee Holding's ROCE
While that is good to see, Coffee Holding has a low ROCE and does not look attractive in this analysis. You might be able to find a better investment than Coffee Holding. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.