Returns On Capital Signal Tricky Times Ahead For China Gingko Education Group (HKG:1851)

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating China Gingko Education Group (HKG:1851), we don't think it's current trends fit the mold of a multi-bagger.

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. 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)

0.087 = CN¥81m ÷ (CN¥1.2b - CN¥256m) (Based on the trailing twelve months to June 2022).

Therefore, China Gingko Education Group has an ROCE of 8.7%. Even though it's in line with the industry average of 8.7%, it's still a low return by itself.

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 The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at China Gingko Education Group, we didn't gain much confidence. Around five years ago the returns on capital were 14%, but since then they've fallen to 8.7%. 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 Gingko Education Group has done well to pay down its current liabilities to 22% 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. 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.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that China Gingko Education Group is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 56% over the last three years, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

If you'd like to know about the risks facing China Gingko Education Group, we've discovered 3 warning signs that you should be aware of.

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. 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.