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Today we are going to look at Hailiang Education Group Inc. (NASDAQ:HLG) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. 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'.
So, How Do We Calculate ROCE?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Hailiang Education Group:
0.24 = CN¥400m ÷ (CN¥2.5b - CN¥806m) (Based on the trailing twelve months to June 2019.)
So, Hailiang Education Group has an ROCE of 24%.
Does Hailiang Education Group Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Hailiang Education Group's ROCE is meaningfully better than the 8.9% average in the Consumer Services industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of the industry comparison, in absolute terms, Hailiang Education Group's ROCE currently appears to be excellent.
In our analysis, Hailiang Education Group's ROCE appears to be 24%, compared to 3 years ago, when its ROCE was 11%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how Hailiang Education Group's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. How cyclical is Hailiang Education Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Hailiang 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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Hailiang Education Group has total liabilities of CN¥806m and total assets of CN¥2.5b. Therefore its current liabilities are equivalent to approximately 32% of its total assets. A medium level of current liabilities boosts Hailiang Education Group's ROCE somewhat.
Our Take On Hailiang Education Group's ROCE
Still, it has a high ROCE, and may be an interesting prospect for further research. Hailiang 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
If you spot an error that warrants correction, please contact the editor at email@example.com. 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.
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. Thank you for reading.