There Are Reasons To Feel Uneasy About China Xinhua Education Group's (HKG:2779) Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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?

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. 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)

0.10 = CN¥312m ÷ (CN¥3.6b - CN¥464m) (Based on the trailing twelve months to December 2020).

So, China Xinhua Education Group has an ROCE of 10%. In absolute terms, that's a satisfactory return, but compared to the Consumer Services industry average of 8.1% it's much better.

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'd like to see what analysts are forecasting going forward, you should check out our free report for China Xinhua Education Group.

What Does the ROCE Trend For China Xinhua Education Group Tell Us?

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 25% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, China Xinhua Education Group has decreased its current liabilities to 13% 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. 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

Bringing it all together, while we're somewhat encouraged by China Xinhua Education Group's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 25% over the last three years, investors may not be too optimistic on this trend improving either. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

If you want to continue researching China Xinhua Education Group, you might be interested to know about the 1 warning sign that our analysis has discovered.

While China Xinhua Education Group isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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