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

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Arco Platform (NASDAQ:ARCE), it didn't seem to tick all of these boxes.

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. The formula for this calculation on Arco Platform is:

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

0.028 = R$130m ÷ (R$6.0b - R$1.4b) (Based on the trailing twelve months to December 2021).

So, Arco Platform has an ROCE of 2.8%. Ultimately, that's a low return and it under-performs the Consumer Services industry average of 6.1%.

See our latest analysis for Arco Platform

In the above chart we have measured Arco Platform's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

We weren't thrilled with the trend because Arco Platform's ROCE has reduced by 84% over the last five years, while the business employed 1,584% more capital. 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. It's also worth noting the company's latest EBIT figure is within 10% of the previous year, so it's fair to assign the ROCE drop largely to the capital raise.

The Bottom Line On Arco Platform's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Arco Platform is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 53% in the last three years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you're still interested in Arco Platform it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.

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.