Here's What To Make Of Scholar Education Group's (HKG:1769) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Scholar Education Group (HKG:1769) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding 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. Analysts use this formula to calculate it for Scholar Education Group:

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

0.081 = CN¥79m ÷ (CN¥1.4b - CN¥415m) (Based on the trailing twelve months to June 2020).

Thus, Scholar Education Group has an ROCE of 8.1%. On its own, that's a low figure but it's around the 9.3% average generated by the Consumer Services industry.

See our latest analysis for Scholar Education Group

Above you can see how the current ROCE for Scholar Education Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Scholar Education Group.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Scholar Education Group doesn't inspire confidence. Over the last three years, returns on capital have decreased to 8.1% from 44% three years ago. 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, Scholar Education Group has done well to pay down its current liabilities to 30% of total assets. Since the ratio used to be 80%, that's a significant reduction and it no doubt explains the drop 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

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 Scholar Education Group. And the stock has followed suit returning a meaningful 12% to shareholders over the last year. So should these growth trends continue, we'd be optimistic on the stock going forward.

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

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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