Be Wary Of G8 Education (ASX:GEM) And Its Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at G8 Education (ASX:GEM) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for G8 Education, this is the formula:

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

0.072 = AU$115m ÷ (AU$1.8b - AU$244m) (Based on the trailing twelve months to June 2023).

Therefore, G8 Education has an ROCE of 7.2%. On its own that's a low return on capital but it's in line with the industry's average returns of 7.2%.

View our latest analysis for G8 Education

In the above chart we have measured G8 Education's 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 G8 Education.

What Can We Tell From G8 Education's ROCE Trend?

In terms of G8 Education's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 7.2% from 15% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, G8 Education has done well to pay down its current liabilities to 13% 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.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by G8 Education's reinvestment in its own business, we're aware that returns are shrinking. And in the last five years, the stock has given away 48% so the market doesn't look too hopeful on these trends strengthening any time soon. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

One more thing, we've spotted 1 warning sign facing G8 Education that you might find interesting.

While G8 Education may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.