Returns On Capital At La Kaffa International (GTSM:2732) Paint An Interesting Picture

What trends should we look for it we want to identify stocks that can 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. In light of that, when we looked at La Kaffa International (GTSM:2732) and its ROCE trend, we weren't exactly thrilled.

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 La Kaffa International, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.11 = NT$264m ÷ (NT$4.3b - NT$2.0b) (Based on the trailing twelve months to September 2020).

Therefore, La Kaffa International has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Hospitality industry average of 5.6% it's much better.

View our latest analysis for La Kaffa International

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating La Kaffa International's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

In terms of La Kaffa International's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 21%, but since then they've fallen to 11%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, La Kaffa International's current liabilities have increased over the last five years to 46% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Bottom Line On La Kaffa International's ROCE

In summary, we're somewhat concerned by La Kaffa International's diminishing returns on increasing amounts of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 97% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One more thing, we've spotted 4 warning signs facing La Kaffa International that you might find interesting.

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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