Here's What To Make Of China Xinhua Education Group's (HKG:2779) Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at China Xinhua Education Group (HKG:2779) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What is it?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed 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)

0.084 = CN¥254m ÷ (CN¥3.3b - CN¥246m) (Based on the trailing twelve months to June 2020).

So, China Xinhua Education Group has an ROCE of 8.4%. On its own, that's a low figure but it's around the 9.3% average generated by the Consumer Services industry.

View 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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From China Xinhua Education Group's ROCE Trend?

In terms of China Xinhua Education Group's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 28% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. 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 7.5% 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. 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 Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for China Xinhua Education Group. However, total returns to shareholders over the last year have been flat, which could indicate these growth trends potentially aren't accounted for yet by investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One more thing, we've spotted 1 warning sign facing China Xinhua Education Group that you might find interesting.

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This article by Simply Wall St is general in nature. 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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