In This Article:
Today we are going to look at Top Education Group Ltd (HKG:1752) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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 Top Education Group:
0.15 = AU$7.8m ÷ (AU$60m - AU$7.7m) (Based on the trailing twelve months to December 2018.)
Therefore, Top Education Group has an ROCE of 15%.
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Does Top Education Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, we find that Top Education Group's ROCE is meaningfully better than the 11% average in the Consumer Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Top Education Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
As we can see, Top Education Group currently has an ROCE of 15%, less than the 43% it reported 3 years ago. So investors might consider if it has had issues recently.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. How cyclical is Top Education Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.