Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. With that in mind, we've noticed some promising trends at China New Higher Education Group (HKG:2001) so let's look a bit deeper.

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. The formula for this calculation on China New Higher Education Group is:

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

0.11 = CN¥608m ÷ (CN¥8.2b - CN¥2.6b) (Based on the trailing twelve months to February 2022).

So, China New Higher Education Group has an ROCE of 11%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Consumer Services industry average of 9.9%.

View our latest analysis for China New Higher Education Group

In the above chart we have measured China New Higher Education Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for China New Higher Education Group.

What Can We Tell From China New Higher Education Group's ROCE Trend?

Investors would be pleased with what's happening at China New Higher Education Group. Over the last five years, returns on capital employed have risen substantially to 11%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 184%. So we're very much inspired by what we're seeing at China New Higher Education Group thanks to its ability to profitably reinvest capital.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 32% of its operations, which isn't ideal. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

What We Can Learn From China New Higher Education Group's ROCE

In summary, it's great to see that China New Higher Education Group can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 1.2% to shareholders. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.

China New Higher Education Group does have some risks though, and we've spotted 3 warning signs for China New Higher Education Group that you might be interested in.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.