What Should Investors Know About The Hershey Company’s (NYSE:HSY) Return On Capital?

I am writing today to help inform people who are new to the stock market and want a simplistic look at the return on The Hershey Company (NYSE:HSY) stock.

Purchasing Hershey gives you an ownership stake in the company. As a result, your investment is being put to work to fund operations and if you want to earn an attractive return on your investment, the business needs to be making an adequate amount of money from the funds you provide. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. Thus, to understand how your money can grow by investing in Hershey, you need to look at what the company returns to owners for the use of their capital, which can be done in many ways but today we will use return on capital employed (ROCE).

See our latest analysis for Hershey

What is Return on Capital Employed (ROCE)?

As an investor you have many alternative companies to choose from, which means there is an opportunity cost in any investment you make in the form of a foregone investment in another company. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business’ ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if Hershey is good at growing investor capital. I have calculated Hershey’s ROCE for you below:

ROCE Calculation for HSY

Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)

Capital Employed = (Total Assets – Current Liabilities)

∴ ROCE = US$1.53b ÷ (US$7.33b – US$3.71b) = 42.16%

The calculation above shows that HSY’s earnings were 42.16% of capital employed. A good ROCE hurdle you should aim for in your investments is 15%, which is exceeded by HSY and means the company creates an excellent amount of earnings on capital employed. If this can be sustained with good reinvestment opportunities or dividend distributions your capital has the potential to compound extremely well over time.

NYSE:HSY Last Perf July 20th 18
NYSE:HSY Last Perf July 20th 18

Does this mean I should invest?

HSY is efficient with the use of capital, but this is only the case if HSY continues to maintain the presently healthy ROCE, which will change if the company either earns less or requires more capital to create earnings. Because of this, it is important to look beyond the final value of HSY’s ROCE and understand what is happening to the individual components. Three years ago, HSY’s ROCE was 37.79%, which means the company’s capital returns have improved. Similarly, the movement in the earnings variable shows a jump from US$1.35b to US$1.53b whilst the amount of capital employed also grew but by a proportionally lesser volume, which suggests the larger ROCE is due to a growth in earnings relative to capital requirements.

Next Steps

HSY’s investors have enjoyed an upward trend in ROCE and it is above a benchmark that makes the company a potentially attractive stock that can achieve a solid return on investment. This makes the company an attractive place to put your money, but ROCE does not tell the whole picture so you need to pay attention to other fundamentals like future prospects and valuation. It’s important to account for these factors because you cannot be sure if this trend will continue or if you are getting a good deal for the future returns you are paying for. If you’re interested in diving deeper, take a look at what I’ve linked below for further information on these fundamentals and other potential investment opportunities.

  1. Future Outlook: What are well-informed industry analysts predicting for HSY’s future growth? Take a look at our free research report of analyst consensus for HSY’s outlook.
  2. Valuation: What is HSY worth today? Is the stock undervalued, even if its ROCE is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether HSY is currently mispriced by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.