Returns On Capital At Kip McGrath Education Centres (ASX:KME) Paint A Concerning Picture

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Kip McGrath Education Centres (ASX:KME) and its ROCE trend, we weren't exactly thrilled.

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

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

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

0.10 = AU$2.9m ÷ (AU$35m - AU$7.1m) (Based on the trailing twelve months to December 2024).

Therefore, Kip McGrath Education Centres has an ROCE of 10%. That's a relatively normal return on capital, and it's around the 9.4% generated by the Consumer Services industry.

Check out our latest analysis for Kip McGrath Education Centres

Historical performance is a great place to start when researching a stock so above you can see the gauge for Kip McGrath Education Centres' ROCE against it's prior returns. If you'd like to look at how Kip McGrath Education Centres has performed in the past in other metrics, you can view this free graph of Kip McGrath Education Centres' past earnings, revenue and cash flow .

How Are Returns Trending?

On the surface, the trend of ROCE at Kip McGrath Education Centres doesn't inspire confidence. Over the last five years, returns on capital have decreased to 10% from 23% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Kip McGrath Education Centres has decreased its current liabilities to 20% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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 Bottom Line On Kip McGrath Education Centres' ROCE

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 there could be an opportunity here if other metrics look good too, because the stock has declined 55% in the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Kip McGrath Education Centres (of which 1 doesn't sit too well with us!) that you should know about.

While Kip McGrath Education Centres isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.