This article is intended for those of you who are at the beginning of your investing journey and want to begin learning the link between The Hershey Company (NYSE:HSY)’s return fundamentals and stock market performance.
If you purchase a HSY share you are effectively becoming a partner with many other shareholders. 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. You need to pay attention to this because your return on investment is linked to dividends and internal investments to improve the business, which can only occur if the company is expected to produce adequate earnings with the capital that has been provided. Therefore, looking at how efficiently Hershey is able to use capital to create earnings will help us understand your potential return. Investors use many different metrics but the analysis below focuses on return on capital employed (ROCE). Let’s take a look at what it can tell us.
ROCE: Explanation and Calculation
When you choose to invest in a company, there is an opportunity cost because that money could’ve been invested elsewhere. 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. We’ll look at Hershey’s returns by computing return on capital employed, which will tell us what the company can generate from the money spent in operations. HSY’s ROCE is calculated below:
ROCE Calculation for HSY
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = US$1.5b ÷ (US$7.8b – US$2.8b) = 32%
As you can see, HSY earned $32 from every $100 you invested over the previous twelve months. This makes Hershey exceptionally profitable when compared to a robust 15% ROCE yardstick. So if this rate continues in to the future and is able to either provide solid dividends or reinvestment opportunities, your capital will enlarge at a rapid rate over time.
Before moving forward
The encouraging ROCE is good news for Hershey investors if the company is able to maintain strong earnings and control their capital needs. But if this doesn’t occur, HSY’s ROCE may deteriorate, in which case your money is better invested elsewhere. 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. If you go back three years, you’ll find that HSY’s ROCE has decreased from 43%. With this, the current earnings of US$1.5b improved from US$1.4b however capital employed has increased by a proportionally greater amount as a result of a rise in total assets , which suggests investor’s ROCE has fallen because the company requires more capital to create earnings despite the previous growth in EBT.
Although Hershey’s ROCE has decreased over the past few years, the company still remains an attractive candidate that is capable of producing solid capital returns and a potentially strong return on investment. Before making any decisions, ROCE does not tell the whole picture so you need to pay attention to other fundamentals like future prospects and valuation. If you don’t pay attention to these factors you cannot be sure if the downward path is a signal to run, or just a blip in an otherwise solid return profile. 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.
- 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.
- 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.
- 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 past 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 firstname.lastname@example.org.