What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. Having said that, from a first glance at Scholar Education Group (HKG:1769) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What Is It?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Scholar Education Group, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.11 = CN¥39m ÷ (CN¥586m - CN¥216m) (Based on the trailing twelve months to June 2022).

Thus, Scholar Education Group has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 8.7% generated by the Consumer Services industry.

See our latest analysis for Scholar Education Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for Scholar Education Group's ROCE against it's prior returns. If you're interested in investigating Scholar Education Group's past further, check out this free graph of past earnings, revenue and cash flow.

So How Is Scholar Education Group's ROCE Trending?

On the surface, the trend of ROCE at Scholar Education Group doesn't inspire confidence. Around five years ago the returns on capital were 44%, but since then they've fallen to 11%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Scholar Education Group has done well to pay down its current liabilities to 37% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

We're a bit apprehensive about Scholar Education Group because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Unsurprisingly then, the stock has dived 79% over the last three years, so investors are recognizing these changes and don't like the company's prospects. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

If you'd like to know about the risks facing Scholar Education Group, we've discovered 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.