Investors Could Be Concerned With Kip McGrath Education Centres' (ASX:KME) 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? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Kip McGrath Education Centres (ASX:KME), it didn't seem to tick all of these boxes.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Kip McGrath Education Centres, this is the formula:

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

0.11 = AU$2.5m ÷ (AU$35m - AU$12m) (Based on the trailing twelve months to December 2021).

So, Kip McGrath Education Centres has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Consumer Services industry average of 6.7% it's much better.

View our latest analysis for Kip McGrath Education Centres

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Kip McGrath Education Centres' past further, check out this free graph of past earnings, revenue and cash flow.

So How Is Kip McGrath Education Centres' ROCE Trending?

In terms of Kip McGrath Education Centres' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 20% over the last five years. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 35%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

The Bottom Line

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Kip McGrath Education Centres. And the stock has done incredibly well with a 213% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

One more thing: We've identified 5 warning signs with Kip McGrath Education Centres (at least 2 which don't sit too well with us) , and understanding these would certainly be useful.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.