Some Investors May Be Worried About Calavo Growers' (NASDAQ:CVGW) Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out 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. Having said that, from a first glance at Calavo Growers (NASDAQ:CVGW) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What is 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. To calculate this metric for Calavo Growers, this is the formula:

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

0.10 = US$38m ÷ (US$446m - US$81m) (Based on the trailing twelve months to January 2021).

So, Calavo Growers has an ROCE of 10%. On its own, that's a standard return, however it's much better than the 8.4% generated by the Food industry.

Check out our latest analysis for Calavo Growers

In the above chart we have measured Calavo Growers' 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 Calavo Growers.

How Are Returns Trending?

In terms of Calavo Growers' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 24% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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 related note, Calavo Growers has decreased its current liabilities to 18% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

Our Take On Calavo Growers' ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Calavo Growers have fallen, meanwhile the business is employing more capital than it was five years ago. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 49% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Like most companies, Calavo Growers does come with some risks, and we've found 2 warning signs that you should be aware of.

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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