G8 Education (ASX:GEM) Is Reinvesting At Lower Rates Of Return
To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. Having said that, from a first glance at G8 Education (ASX:GEM) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What Is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for G8 Education, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.072 = AU$115m ÷ (AU$1.8b - AU$244m) (Based on the trailing twelve months to June 2023).
Therefore, G8 Education has an ROCE of 7.2%. On its own that's a low return on capital but it's in line with the industry's average returns of 7.2%.
View our latest analysis for G8 Education
Above you can see how the current ROCE for G8 Education compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Can We Tell From G8 Education's ROCE Trend?
On the surface, the trend of ROCE at G8 Education doesn't inspire confidence. To be more specific, ROCE has fallen from 15% over the last five years. However it looks like G8 Education might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
On a side note, G8 Education has done well to pay down 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.
The Key Takeaway
To conclude, we've found that G8 Education is reinvesting in the business, but returns have been falling. And in the last five years, the stock has given away 56% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think G8 Education has the makings of a multi-bagger.
One more thing, we've spotted 1 warning sign facing G8 Education that you might find interesting.
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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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.
