When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. And from a first read, things don't look too good at Qtone Education Group (Guangdong)Ltd (SZSE:300359), so let's see why.
Return On Capital Employed (ROCE): What Is It?
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 Qtone Education Group (Guangdong)Ltd, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.028 = CN¥24m ÷ (CN¥1.2b - CN¥298m) (Based on the trailing twelve months to September 2022).
Thus, Qtone Education Group (Guangdong)Ltd has an ROCE of 2.8%. In absolute terms, that's a low return and it also under-performs the Software industry average of 4.2%.
View our latest analysis for Qtone Education Group (Guangdong)Ltd
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'd like to look at how Qtone Education Group (Guangdong)Ltd has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
We aren't too thrilled by the trend because ROCE has declined 44% over the last five years and despite the capital raising conducted before the latest reports, the business has -62% less capital employed.
The Bottom Line
In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. It should come as no surprise then that the stock has fallen 21% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
One more thing: We've identified 2 warning signs with Qtone Education Group (Guangdong)Ltd (at least 1 which makes us a bit uncomfortable) , and understanding them would certainly be useful.
While Qtone Education Group (Guangdong)Ltd 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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