Returns On Capital At Wah Fu Education Group (NASDAQ:WAFU) Have Stalled

There are a few key trends to look for if we want to identify the next multi-bagger. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don't think Wah Fu Education Group (NASDAQ:WAFU) 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 Wah Fu Education Group, this is the formula:

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

0.087 = US$1.0m ÷ (US$18m - US$6.0m) (Based on the trailing twelve months to March 2022).

Therefore, Wah Fu Education Group has an ROCE of 8.7%. On its own that's a low return, but compared to the average of 6.0% generated by the Consumer Services industry, it's much better.

View 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.

What The Trend Of ROCE Can Tell Us

The returns on capital haven't changed much for Wah Fu Education Group in recent years. The company has consistently earned 8.7% for the last five years, and the capital employed within the business has risen 92% in that time. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 33% of total assets, this reported ROCE would probably be less than8.7% because total capital employed would be higher.The 8.7% ROCE could be even lower if current liabilities weren't 33% of total assets, because the the formula would show a larger base of total capital employed. With that in mind, just be wary if this ratio increases in the future, because if it gets particularly high, this brings with it some new elements of risk.

The Key Takeaway

In summary, Wah Fu Education Group has simply been reinvesting capital and generating the same low rate of return as before. And with the stock having returned a mere 5.6% in the last three years to shareholders, you could argue that they're aware of these lackluster trends. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

One more thing: We've identified 3 warning signs with Wah Fu Education Group (at least 1 which doesn't sit too well with us) , and understanding these would certainly be useful.

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.

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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.