Here's What's Concerning About China 21st Century Education Group's (HKG:1598) Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at China 21st Century Education Group (HKG:1598), it didn't seem to tick all of these boxes.

Understanding 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. To calculate this metric for China 21st Century Education Group, this is the formula:

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

0.046 = CN¥38m ÷ (CN¥1.4b - CN¥553m) (Based on the trailing twelve months to December 2021).

Thus, China 21st Century Education Group has an ROCE of 4.6%. In absolute terms, that's a low return and it also under-performs the Consumer Services industry average of 9.9%.

See our latest analysis for China 21st Century Education Group

In the above chart we have measured China 21st Century Education Group'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 China 21st Century Education Group here for free.

What Can We Tell From China 21st Century Education Group's ROCE Trend?

On the surface, the trend of ROCE at China 21st Century Education Group doesn't inspire confidence. Around five years ago the returns on capital were 30%, but since then they've fallen to 4.6%. 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.

On a side note, China 21st Century Education Group has done well to pay down its current liabilities to 40% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

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 China 21st Century Education Group. However, despite the promising trends, the stock has fallen 34% over the last three years, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

One more thing to note, we've identified 2 warning signs with China 21st Century Education Group and understanding these should be part of your investment process.

While China 21st Century Education Group may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.