If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Speaking of which, we noticed some great changes in Costa Group Holdings' (ASX:CGC) returns on capital, so let's have a look.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Costa Group Holdings is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.091 = AU$100m ÷ (AU$1.3b - AU$217m) (Based on the trailing twelve months to December 2020).
So, Costa Group Holdings has an ROCE of 9.1%. On its own that's a low return, but compared to the average of 5.8% generated by the Food industry, it's much better.
In the above chart we have measured Costa Group Holdings' 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 Costa Group Holdings.
How Are Returns Trending?
We're glad to see that ROCE is heading in the right direction, even if it is still low at the moment. The data shows that returns on capital have increased substantially over the last five years to 9.1%. Basically the business is earning more per dollar of capital invested and in addition to that, 135% more capital is being employed now too. So we're very much inspired by what we're seeing at Costa Group Holdings thanks to its ability to profitably reinvest capital.
The Key Takeaway
All in all, it's terrific to see that Costa Group Holdings is reaping the rewards from prior investments and is growing its capital base. Since the stock has returned a solid 43% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
Costa Group Holdings does have some risks though, and we've spotted 2 warning signs for Costa Group Holdings that you might be interested in.
While Costa Group Holdings 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.
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