Kip McGrath Education Centres (ASX:KME) Could Be Struggling To Allocate Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Kip McGrath Education Centres (ASX:KME) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

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. The formula for this calculation on Kip McGrath Education Centres is:

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

0.068 = AU$1.7m ÷ (AU$36m - AU$10m) (Based on the trailing twelve months to December 2023).

Thus, Kip McGrath Education Centres has an ROCE of 6.8%. On its own, that's a low figure but it's around the 7.7% average generated by the Consumer Services industry.

Check out 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 want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Kip McGrath Education Centres.

What The Trend Of ROCE Can Tell Us

In terms of Kip McGrath Education Centres' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 26%, but since then they've fallen to 6.8%. 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 Key Takeaway

While returns have fallen for Kip McGrath Education Centres in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. However, despite the promising trends, the stock has fallen 62% over the last five years, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

If you want to know some of the risks facing Kip McGrath Education Centres we've found 3 warning signs (1 is significant!) that you should be aware of before investing here.

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.