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

To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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?

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 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 September 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 6.4%.

See our latest analysis for Wah Fu Education Group

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Wah Fu Education Group has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

In terms of Wah Fu Education Group's historical ROCE movements, the trend isn't fantastic. 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%. 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.

Our Take On Wah Fu Education Group's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Wah Fu Education Group is reinvesting for growth and has higher sales as a result. But since the stock has dived 71% in the last year, there could be other drivers that are influencing the business' outlook. Regardless, reinvestment can pay off in the long run, so we think astute investors may want to look further into this stock.

If you'd like to know about the risks facing Wah Fu Education Group, we've discovered 2 warning signs that you should be aware of.

While Wah Fu Education Group 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.