Today we'll look at Top Education Group Ltd (HKG:1752) and reflect on its potential as an investment. 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 Top Education Group:
0.066 = AU$3.6m ÷ (AU$59m - AU$5.7m) (Based on the trailing twelve months to June 2019.)
So, Top Education Group has an ROCE of 6.6%.
Is Top Education Group's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Top Education Group's ROCE appears to be significantly below the 10% average in the Consumer Services industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, Top Education Group's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
Top Education Group's current ROCE of 6.6% is lower than 3 years ago, when the company reported a 43% ROCE. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Top Education Group's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. You can check if Top Education Group has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How Top Education Group's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
Top Education Group has total assets of AU$59m and current liabilities of AU$5.7m. Therefore its current liabilities are equivalent to approximately 9.7% of its total assets. Top Education Group has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
Our Take On Top Education Group's ROCE
Top Education Group looks like an ok business, but on this analysis it is not at the top of our buy list. You might be able to find a better investment than Top Education Group. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.