Arco Platform (NASDAQ:ARCE) Could Be Struggling To Allocate Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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 Arco Platform (NASDAQ:ARCE) 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 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 Arco Platform:

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

0.037 = R$120m ÷ (R$4.5b - R$1.2b) (Based on the trailing twelve months to June 2021).

Therefore, Arco Platform has an ROCE of 3.7%. In absolute terms, that's a low return and it also under-performs the Consumer Services industry average of 8.2%.

See our latest analysis for Arco Platform

Above you can see how the current ROCE for Arco Platform 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.

How Are Returns Trending?

Unfortunately, the trend isn't great with ROCE falling from 19% four years ago, while capital employed has grown 922%. Usually this isn't ideal, but given Arco Platform conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Arco Platform might not have received a full period of earnings contribution from it.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 28%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 3.7%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

The Bottom Line On Arco Platform's ROCE

While returns have fallen for Arco Platform in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. However, despite the promising trends, the stock has fallen 49% over the last year, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you want to continue researching Arco Platform, you might be interested to know about the 2 warning signs that our analysis has discovered.

While Arco Platform may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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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