Karat Packaging (NASDAQ:KRT) Hasn't Managed To Accelerate Its Returns

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, the ROCE of Karat Packaging (NASDAQ:KRT) looks decent, right now, so lets see what the trend of returns can tell us.

What Is 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 Karat Packaging:

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

0.14 = US$30m ÷ (US$247m - US$37m) (Based on the trailing twelve months to June 2022).

So, Karat Packaging has an ROCE of 14%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Trade Distributors industry average of 15%.

See our latest analysis for Karat Packaging

In the above chart we have measured Karat Packaging'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 Karat Packaging.

What Does the ROCE Trend For Karat Packaging Tell Us?

While the returns on capital are good, they haven't moved much. Over the past four years, ROCE has remained relatively flat at around 14% and the business has deployed 698% more capital into its operations. 14% is a pretty standard return, and it provides some comfort knowing that Karat Packaging has consistently earned this amount. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.

On a side note, Karat Packaging has done well to reduce current liabilities to 15% of total assets over the last four years. Effectively suppliers now fund less of the business, which can lower some elements of risk.

The Bottom Line On Karat Packaging's ROCE

In the end, Karat Packaging has proven its ability to adequately reinvest capital at good rates of return. Yet over the last year the stock has declined 13%, so the decline might provide an opening. That's why we think it'd be worthwhile to look further into this stock given the fundamentals are appealing.

Karat Packaging does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is potentially serious...

While Karat Packaging 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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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.