Scholar Education Group's (HKG:1769) Returns On Capital Not Reflecting Well On The Business

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Scholar Education Group (HKG:1769) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. To calculate this metric for Scholar Education Group, this is the formula:

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

0.11 = CN¥39m ÷ (CN¥586m - CN¥216m) (Based on the trailing twelve months to June 2022).

So, Scholar Education Group has an ROCE of 11%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Consumer Services industry average of 8.9%.

Check out our latest analysis for Scholar Education Group

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

How Are Returns Trending?

On the surface, the trend of ROCE at Scholar Education Group doesn't inspire confidence. Around five years ago the returns on capital were 44%, but since then they've fallen to 11%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Scholar Education Group has done well to pay down its current liabilities to 37% 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. 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 Key Takeaway

In summary, we're somewhat concerned by Scholar Education Group's diminishing returns on increasing amounts of capital. This could explain why the stock has sunk a total of 90% in the last three years. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One more thing: We've identified 2 warning signs with Scholar Education Group (at least 1 which is concerning) , and understanding these would certainly be useful.

While Scholar Education Group 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.