What Do The Returns On Capital At China Gingko Education Group (HKG:1851) Tell Us?

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at China Gingko Education Group (HKG:1851) and its ROCE trend, we weren't exactly thrilled.

What is 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. 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)

0.028 = CN¥26m ÷ (CN¥1.1b - CN¥169m) (Based on the trailing twelve months to June 2020).

Therefore, China Gingko Education Group has an ROCE of 2.8%. Ultimately, that's a low return and it under-performs the Consumer Services industry average of 9.3%.

See 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'd like to look at how China Gingko Education Group has performed in the past in other metrics, you can view 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 four years ago the returns on capital were 15%, but since then they've fallen to 2.8%. 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 related note, China Gingko Education Group has decreased its current liabilities to 15% 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.

The Key Takeaway

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 23% so the market doesn't look too hopeful on these trends strengthening any time soon. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

China Gingko Education Group does come with some risks though, we found 5 warning signs in our investment analysis, and 3 of those are a bit concerning...

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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