Today we'll evaluate China 21st Century Education Group Limited (HKG:1598) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
How Do You Calculate Return On Capital Employed?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for China 21st Century Education Group:
0.10 = CN¥70m ÷ (CN¥926m - CN¥232m) (Based on the trailing twelve months to June 2019.)
So, China 21st Century Education Group has an ROCE of 10%.
Is China 21st Century Education Group's ROCE Good?
One way to assess ROCE is to compare similar companies. We can see China 21st Century Education Group's ROCE is around the 10% average reported by the Consumer Services industry. Independently of how China 21st Century Education Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
China 21st Century Education Group's current ROCE of 10% is lower than its ROCE in the past, which was 23%, 3 years ago. So investors might consider if it has had issues recently. The image below shows how China 21st Century Education Group's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. How cyclical is China 21st Century Education Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
China 21st Century Education Group's Current Liabilities And Their Impact On Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.
China 21st Century Education Group has total liabilities of CN¥232m and total assets of CN¥926m. Therefore its current liabilities are equivalent to approximately 25% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From China 21st Century Education Group's ROCE
With that in mind, China 21st Century Education Group's ROCE appears pretty good. China 21st Century Education Group looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.