What are the early trends we should look for to identify a stock that could multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in Cham Foods (Israel)'s (TLV:CHAM) returns on capital, so let's have a look.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Cham Foods (Israel), this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.085 = US$1.6m ÷ (US$36m - US$17m) (Based on the trailing twelve months to June 2021).
Therefore, Cham Foods (Israel) has an ROCE of 8.5%. In absolute terms, that's a low return and it also under-performs the Food industry average of 15%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Cham Foods (Israel)'s ROCE against it's prior returns. If you're interested in investigating Cham Foods (Israel)'s past further, check out this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Cham Foods (Israel) Tell Us?
We're delighted to see that Cham Foods (Israel) is reaping rewards from its investments and has now broken into profitability. The company was generating losses five years ago, but now it's turned around, earning 8.5% which is no doubt a relief for some early shareholders. In regards to capital employed, Cham Foods (Israel) is using 38% less capital than it was five years ago, which on the surface, can indicate that the business has become more efficient at generating these returns. This could potentially mean that the company is selling some of its assets.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 47% of its operations, which isn't ideal. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.
The Bottom Line
From what we've seen above, Cham Foods (Israel) has managed to increase it's returns on capital all the while reducing it's capital base. Since the stock has returned a solid 69% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.
One final note, you should learn about the 4 warning signs we've spotted with Cham Foods (Israel) (including 1 which is a bit concerning) .
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.