Capital Allocation Trends At Wah Fu Education Group (NASDAQ:WAFU) Aren't Ideal

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Wah Fu Education Group (NASDAQ:WAFU), it didn't seem to tick all of these boxes.

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 Wah Fu Education Group, this is the formula:

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

0.10 = US$1.1m ÷ (US$17m - US$6.1m) (Based on the trailing twelve months to March 2021).

Thus, Wah Fu Education Group has an ROCE of 10.0%. In absolute terms, that's a low return, but it's much better than the Consumer Services industry average of 7.6%.

See our latest analysis for Wah Fu Education Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for Wah Fu Education Group's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Wah Fu Education Group, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Wah Fu Education Group doesn't inspire confidence. Around five years ago the returns on capital were 44%, but since then they've fallen to 10.0%. 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. If these investments prove successful, this can bode very well for long term stock performance.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 36%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 10.0%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

What We Can Learn From Wah Fu Education Group's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Wah Fu Education Group. And the stock has followed suit returning a meaningful 18% to shareholders over the last year. So should these growth trends continue, we'd be optimistic on the stock going forward.

Like most companies, Wah Fu Education Group does come with some risks, and we've found 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.

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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