China Xinhua Education Group (HKG:2779) Could Be Struggling To Allocate Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 briefly looking over the numbers, we don't think China Xinhua Education Group (HKG:2779) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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

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

0.091 = CN¥330m ÷ (CN¥3.9b - CN¥330m) (Based on the trailing twelve months to June 2022).

So, China Xinhua Education Group has an ROCE of 9.1%. Even though it's in line with the industry average of 9.3%, it's still a low return by itself.

See our latest analysis for China Xinhua Education Group

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of China Xinhua Education Group, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at China Xinhua Education Group, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 9.1% from 20% five years ago. 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.

The Bottom Line

While returns have fallen for China Xinhua Education Group in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These growth trends haven't led to growth returns though, since the stock has fallen 54% over the last three years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

China Xinhua Education Group does have some risks though, and we've spotted 1 warning sign for China Xinhua Education Group that you might be interested in.

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.