Some Investors May Be Worried About G8 Education's (ASX:GEM) Returns On Capital

What are the early trends we should look for to identify a stock that could 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating G8 Education (ASX:GEM), we don't think it's current trends fit the mold of a multi-bagger.

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. Analysts use this formula to calculate it for G8 Education:

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

0.075 = AU$119m ÷ (AU$1.8b - AU$254m) (Based on the trailing twelve months to December 2021).

Therefore, G8 Education has an ROCE of 7.5%. Ultimately, that's a low return and it under-performs the Consumer Services industry average of 10%.

See 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, you can check out the forecasts from the analysts covering G8 Education here for free.

The Trend Of ROCE

On the surface, the trend of ROCE at G8 Education doesn't inspire confidence. Around five years ago the returns on capital were 15%, but since then they've fallen to 7.5%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that G8 Education is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 57% over the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

If you're still interested in G8 Education it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.