There are a few key trends to look for if we want to identify the next multi-bagger. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Kip McGrath Education Centres (ASX:KME) and its ROCE trend, we weren't exactly thrilled.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Kip McGrath Education Centres:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.099 = AU$2.5m ÷ (AU$36m - AU$11m) (Based on the trailing twelve months to June 2022).
Thus, Kip McGrath Education Centres has an ROCE of 9.9%. On its own that's a low return, but compared to the average of 5.6% generated by the Consumer Services industry, it's much better.
Above you can see how the current ROCE for Kip McGrath Education Centres compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Does the ROCE Trend For Kip McGrath Education Centres Tell Us?
On the surface, the trend of ROCE at Kip McGrath Education Centres doesn't inspire confidence. Over the last five years, returns on capital have decreased to 9.9% from 17% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
The Bottom Line On Kip McGrath Education Centres' ROCE
While returns have fallen for Kip McGrath Education Centres in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. Furthermore the stock has climbed 95% over the last five years, it would appear that investors are upbeat about the future. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
On a final note, we've found 2 warning signs for Kip McGrath Education Centres that we think 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.
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