With its stock down 7.2% over the past month, it is easy to disregard Coffee Holding (NASDAQ:JVA). It is possible that the markets have ignored the company’s differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company’s financials. Particularly, we will be paying attention to Coffee Holding’s ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Do You Calculate Return On Equity?
Return on equity can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Coffee Holding is:
3.4% = US$971k ÷ US$29m (Based on the trailing twelve months to January 2021).
The ‘return’ refers to a company’s earnings over the last year. So, this means that for every $1 of its shareholder’s investments, the company generates a profit of $0.03.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company’s future earnings. Based on how much of its profits the company chooses to reinvest or “retain”, we are then able to evaluate a company’s future ability to generate profits. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don’t have the same features.
A Side By Side comparison of Coffee Holding’s Earnings Growth And 3.4% ROE
As you can see, Coffee Holding’s ROE looks pretty weak. Even compared to the average industry ROE of 11%, the company’s ROE is quite dismal. Given the circumstances, the significant decline in net income by 33% seen by Coffee Holding over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
Next, when we compared with the industry, which has shrunk its earnings at a rate of 2.2% in the same period, we still found Coffee Holding’s performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Coffee Holding fairly valued compared to other companies?
Is Coffee Holding Using Its Retained Earnings Effectively?
Coffee Holding doesn’t pay any dividend, meaning that potentially all of its profits are being reinvested in the business, which doesn’t explain why the company’s earnings have shrunk if it is retaining all of its profits. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
In total, we’re a bit ambivalent about Coffee Holding’s performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business.