Be Wary Of Arco Platform (NASDAQ:ARCE) And Its Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after briefly looking over the numbers, we don't think Arco Platform (NASDAQ:ARCE) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Arco Platform, this is the formula:

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

0.069 = R$291m ÷ (R$5.8b - R$1.5b) (Based on the trailing twelve months to December 2022).

Thus, Arco Platform has an ROCE of 6.9%. On its own that's a low return on capital but it's in line with the industry's average returns of 7.0%.

Check out 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'd like, you can check out the forecasts from the analysts covering Arco Platform here for free.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Arco Platform, we didn't gain much confidence. To be more specific, ROCE has fallen from 21% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 27%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

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. Despite these promising trends, the stock has collapsed 78% over the last three years, so there could be other factors hurting the company's prospects. Therefore, we'd suggest researching the stock further to uncover more about the business.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Arco Platform (of which 1 is significant!) that you should know about.

While Arco Platform isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.