What trends should we look for it we want to identify stocks that can multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So while Hershey (NYSE:HSY) has a high ROCE right now, lets see what we can decipher from how returns are changing.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Hershey:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.25 = US$1.8b ÷ (US$9.3b - US$2.2b) (Based on the trailing twelve months to September 2020).
So, Hershey has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Food industry average of 7.9%.
Above you can see how the current ROCE for Hershey compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Hershey.
What Can We Tell From Hershey's ROCE Trend?
In terms of Hershey's historical ROCE movements, the trend isn't fantastic. While it's comforting that the ROCE is high, five years ago it was 43%. However it looks like Hershey might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.On a side note, Hershey has done well to pay down its current liabilities to 24% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
The Bottom Line On Hershey's ROCE
Bringing it all together, while we're somewhat encouraged by Hershey's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 93% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
On a separate note, we've found 1 warning sign for Hershey you'll probably want to know about.
Hershey is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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