Today we are going to look at Four Seasons Education (Cayman) Inc. (NYSE:FEDU) to see whether it might be an attractive investment prospect. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
Firstly, 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.
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. Generally speaking a higher ROCE is better. 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 Four Seasons Education (Cayman):
0.0056 = CN¥5.8m ÷ (CN¥1.2b - CN¥202m) (Based on the trailing twelve months to August 2019.)
Therefore, Four Seasons Education (Cayman) has an ROCE of 0.6%.
Is Four Seasons Education (Cayman)'s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Four Seasons Education (Cayman)'s ROCE appears meaningfully below the 9.3% average reported by the Consumer Services industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Four Seasons Education (Cayman) compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. It is likely that there are more attractive prospects out there.
Four Seasons Education (Cayman)'s current ROCE of 0.6% is lower than 3 years ago, when the company reported a 33% ROCE. This makes us wonder if the business is facing new challenges. The image below shows how Four Seasons Education (Cayman)'s ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Four Seasons Education (Cayman)? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Four Seasons Education (Cayman)'s Current Liabilities And Their Impact On Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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.
Four Seasons Education (Cayman) has total liabilities of CN¥202m and total assets of CN¥1.2b. Therefore its current liabilities are equivalent to approximately 16% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
What We Can Learn From Four Seasons Education (Cayman)'s ROCE
Four Seasons Education (Cayman) has a poor ROCE, and there may be better investment prospects out there. Of course, you might also be able to find a better stock than Four Seasons Education (Cayman). So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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. Thank you for reading.