Returns On Capital Signal Tricky Times Ahead For China Beststudy Education Group (HKG:3978)

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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at China Beststudy Education Group (HKG:3978) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

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 Beststudy Education Group, this is the formula:

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

0.027 = CN¥15m ÷ (CN¥865m - CN¥317m) (Based on the trailing twelve months to June 2023).

Therefore, China Beststudy Education Group has an ROCE of 2.7%. In absolute terms, that's a low return and it also under-performs the Consumer Services industry average of 9.9%.

See our latest analysis for China Beststudy 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'd like to look at how China Beststudy Education Group has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at China Beststudy Education Group doesn't inspire confidence. Over the last five years, returns on capital have decreased to 2.7% from 30% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, China Beststudy Education Group has decreased its current liabilities to 37% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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 Beststudy Education Group's ROCE

In summary, we're somewhat concerned by China Beststudy Education Group's diminishing returns on increasing amounts of capital. This could explain why the stock has sunk a total of 73% in the last three years. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

China Beststudy Education Group does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those shouldn't be ignored...

While China Beststudy Education Group may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.