If you're looking for a multi-bagger, there's a few things to keep an eye out 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Kip McGrath Education Centres (ASX:KME), it didn't seem to tick all of these boxes.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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)
0.07 = AU$1.4m ÷ (AU$29m - AU$8.9m) (Based on the trailing twelve months to December 2020).
Therefore, Kip McGrath Education Centres has an ROCE of 7.0%. In absolute terms, that's a low return and it also under-performs the Consumer Services industry average of 9.4%.
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'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 past earnings, revenue and cash flow.
What Can We Tell From Kip McGrath Education Centres' ROCE Trend?
Unfortunately, the trend isn't great with ROCE falling from 12% five years ago, while capital employed has grown 89%. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Kip McGrath Education Centres might not have received a full period of earnings contribution from it.
The Key Takeaway
In summary, Kip McGrath Education Centres is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 410% gain to shareholders who have held over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
If you'd like to know about the risks facing Kip McGrath Education Centres, we've discovered 5 warning signs that you should be aware of.
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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