China Xinhua Education Group (HKG:2779) Will Want To Turn Around Its Return Trends

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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 Xinhua Education Group (HKG:2779), we don't think it's current trends fit the mold of a multi-bagger.

What is 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. Analysts use this formula to calculate it for China Xinhua Education Group:

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

0.11 = CN¥378m ÷ (CN¥3.8b - CN¥384m) (Based on the trailing twelve months to June 2021).

So, China Xinhua Education Group has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Consumer Services industry average of 7.8% it's much better.

Check out our latest analysis for China Xinhua Education Group

In the above chart we have measured China Xinhua 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 Xinhua Education Group here for free.

How Are Returns Trending?

When we looked at the ROCE trend at China Xinhua Education Group, we didn't gain much confidence. Around five years ago the returns on capital were 23%, but since then they've fallen to 11%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, China Xinhua Education Group has done well to pay down its current liabilities to 10% of total assets. That could partly explain why the ROCE has dropped. 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.

Our Take On China Xinhua Education Group's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that China Xinhua Education Group is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 21% 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.

One more thing to note, we've identified 1 warning sign with China Xinhua Education Group and understanding this should be part of your investment process.

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.

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.

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