There Are Reasons To Feel Uneasy About China Kepei Education Group's (HKG:1890) Returns On Capital

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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating China Kepei Education Group (HKG:1890), 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. To calculate this metric for China Kepei Education Group, this is the formula:

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

0.12 = CN¥453m ÷ (CN¥6.7b - CN¥2.8b) (Based on the trailing twelve months to August 2021).

So, China Kepei Education Group has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 8.2% generated by the Consumer Services industry.

Check out our latest analysis for China Kepei Education Group

In the above chart we have measured China Kepei Education Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering China Kepei Education Group here for free.

So How Is China Kepei Education Group's ROCE Trending?

When we looked at the ROCE trend at China Kepei Education Group, we didn't gain much confidence. To be more specific, ROCE has fallen from 16% over the last five years. 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.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 42%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 12%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Bottom Line On China Kepei Education Group's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that China Kepei Education Group is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 10% gain to shareholders who've held over the last three years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for China Kepei Education Group (of which 1 is concerning!) that you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.