If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at China East Education Holdings (HKG:667), it didn't seem to tick all of these boxes.
Understanding Return On Capital Employed (ROCE)
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 China East Education Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.049 = CN¥337m ÷ (CN¥9.3b - CN¥2.4b) (Based on the trailing twelve months to June 2023).
So, China East Education Holdings has an ROCE of 4.9%. In absolute terms, that's a low return and it also under-performs the Consumer Services industry average of 11%.
View our latest analysis for China East Education Holdings
In the above chart we have measured China East Education Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering China East Education Holdings here for free.
What Can We Tell From China East Education Holdings' ROCE Trend?
When we looked at the ROCE trend at China East Education Holdings, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 4.9% from 51% five years ago. However it looks like China East Education Holdings might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
On a related note, China East Education Holdings has decreased its current liabilities to 25% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Key Takeaway
Bringing it all together, while we're somewhat encouraged by China East Education Holdings' reinvestment in its own business, we're aware that returns are shrinking. And investors may be expecting the fundamentals to get a lot worse because the stock has crashed 81% over the last three years. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.
Like most companies, China East Education Holdings does come with some risks, and we've found 2 warning signs that you should be aware of.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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.
