China YuHua Education (HKG:6169) May Have Issues Allocating Its Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. Although, when we looked at China YuHua Education (HKG:6169), it didn't seem to tick all of these boxes.

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. The formula for this calculation on China YuHua Education is:

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

0.16 = CN¥1.2b ÷ (CN¥9.4b - CN¥2.0b) (Based on the trailing twelve months to February 2021).

Thus, China YuHua Education has an ROCE of 16%. In absolute terms, that's a satisfactory return, but compared to the Consumer Services industry average of 7.7% it's much better.

Check out our latest analysis for China YuHua Education

Above you can see how the current ROCE for China YuHua Education compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for China YuHua Education.

What The Trend Of ROCE Can Tell Us

In terms of China YuHua Education's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 29% over the last five years. 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. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, China YuHua Education has done well to pay down its current liabilities to 21% 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 Key Takeaway

While returns have fallen for China YuHua Education in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. Furthermore the stock has climbed 46% over the last three years, it would appear that investors are upbeat about the future. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

If you want to continue researching China YuHua Education, you might be interested to know about the 2 warning signs that our analysis has discovered.

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.

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