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Today we are going to look at Kip McGrath Education Centres Limited (ASX:KME) 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.
First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Kip McGrath Education Centres:
0.24 = AU$3.0m ÷ (AU$19m - AU$6.9m) (Based on the trailing twelve months to December 2018.)
Therefore, Kip McGrath Education Centres has an ROCE of 24%.
View our latest analysis for Kip McGrath Education Centres
Is Kip McGrath Education Centres's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that Kip McGrath Education Centres's ROCE is meaningfully better than the 14% average in the Consumer Services industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of the industry comparison, in absolute terms, Kip McGrath Education Centres's ROCE currently appears to be excellent.
In our analysis, Kip McGrath Education Centres's ROCE appears to be 24%, compared to 3 years ago, when its ROCE was 12%. This makes us think the business might be improving. You can see in the image below how Kip McGrath Education Centres's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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, after all, simply a snap shot of a single year. If Kip McGrath Education Centres is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.