Today we are going to look at China Kepei Education Group Limited (HKG:1890) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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'.
So, How Do We Calculate ROCE?
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 Kepei Education Group:
0.19 = CN¥298m ÷ (CN¥2.3b - CN¥794m) (Based on the trailing twelve months to December 2018.)
Therefore, China Kepei Education Group has an ROCE of 19%.
Is China Kepei Education Group's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. China Kepei Education Group's ROCE appears to be substantially greater than the 11% average in the Consumer Services industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where China Kepei Education Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
In our analysis, China Kepei Education Group's ROCE appears to be 19%, compared to 3 years ago, when its ROCE was 14%. This makes us think about whether the company has been reinvesting shrewdly.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for China Kepei Education Group.
Do China Kepei Education Group's Current Liabilities Skew 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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
China Kepei Education Group has total assets of CN¥2.3b and current liabilities of CN¥794m. Therefore its current liabilities are equivalent to approximately 34% of its total assets. China Kepei Education Group has a medium level of current liabilities, which would boost the ROCE.
The Bottom Line On China Kepei Education Group's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. China Kepei 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.
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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.