Here's What's Concerning About China Xinhua Education Group's (HKG:2779) Returns On Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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 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. 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)

0.10 = CN¥362m ÷ (CN¥4.0b - CN¥490m) (Based on the trailing twelve months to December 2021).

So, China Xinhua Education Group has an ROCE of 10%. By itself that's a normal return on capital and it's in line with the industry's average returns of 9.9%.

View our latest analysis for China Xinhua Education Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for China Xinhua Education Group's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of China Xinhua Education Group, check out these free graphs here.

The Trend Of ROCE

On the surface, the trend of ROCE at China Xinhua Education Group doesn't inspire confidence. Over the last five years, returns on capital have decreased to 10% from 22% five years ago. 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 12% 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. 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 Bottom Line On China Xinhua Education Group's ROCE

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, despite the promising trends, the stock has fallen 38% over the last three years, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Like most companies, China Xinhua Education Group does come with some risks, and we've found 2 warning signs that you should be aware of.

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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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.