China Gingko Education Group (HKG:1851) May Have Issues Allocating Its Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at China Gingko Education Group (HKG:1851), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What is it?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on China Gingko Education Group is:

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

0.029 = CN¥26m ÷ (CN¥1.2b - CN¥278m) (Based on the trailing twelve months to December 2020).

So, China Gingko Education Group has an ROCE of 2.9%. In absolute terms, that's a low return and it also under-performs the Consumer Services industry average of 8.1%.

View our latest analysis for China Gingko Education Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for China Gingko Education Group's ROCE against it's prior returns. If you're interested in investigating China Gingko Education Group's past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For China Gingko Education Group Tell Us?

When we looked at the ROCE trend at China Gingko Education Group, we didn't gain much confidence. To be more specific, ROCE has fallen from 16% over the last five years. However it looks like China Gingko Education Group might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, China Gingko Education Group has done well to pay down its current liabilities to 24% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From China Gingko Education Group's ROCE

Bringing it all together, while we're somewhat encouraged by China Gingko Education Group's reinvestment in its own business, we're aware that returns are shrinking. And in the last year, the stock has given away 59% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think China Gingko Education Group has the makings of a multi-bagger.

China Gingko Education Group does have some risks, we noticed 4 warning signs (and 2 which are concerning) we think you should know about.

While China Gingko 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. 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.
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