Kip McGrath Education Centres' (ASX:KME) Returns On Capital Not Reflecting Well On The Business
What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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 Kip McGrath Education Centres (ASX:KME) 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)?
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 Kip McGrath Education Centres is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.091 = AU$2.0m ÷ (AU$31m - AU$9.2m) (Based on the trailing twelve months to June 2021).
So, Kip McGrath Education Centres has an ROCE of 9.1%. In absolute terms, that's a low return but it's around the Consumer Services industry average of 10%.
See our latest analysis for Kip McGrath Education Centres
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Kip McGrath Education Centres, check out these free graphs here.
How Are Returns Trending?
When we looked at the ROCE trend at Kip McGrath Education Centres, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 9.1% from 16% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
The Key Takeaway
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Kip McGrath Education Centres. And the stock has done incredibly well with a 287% return over the last five years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
Like most companies, Kip McGrath Education Centres does come with some risks, and we've found 3 warning signs that you should be aware of.
While Kip McGrath Education Centres may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.
