Returns On Capital At Wah Fu Education Group (NASDAQ:WAFU) Paint A Concerning Picture

If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at Wah Fu Education Group (NASDAQ:WAFU) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is Return On Capital Employed (ROCE)?

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. The formula for this calculation on Wah Fu Education Group is:

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

0.094 = US$1.1m ÷ (US$19m - US$6.9m) (Based on the trailing twelve months to September 2021).

Therefore, Wah Fu Education Group has an ROCE of 9.4%. In absolute terms, that's a low return, but it's much better than the Consumer Services industry average of 6.1%.

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 want to delve into the historical earnings, revenue and cash flow of Wah Fu Education Group, check out these free graphs here.

The Trend Of ROCE

When we looked at the ROCE trend at Wah Fu Education Group, we didn't gain much confidence. Around five years ago the returns on capital were 27%, but since then they've fallen to 9.4%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Wah Fu Education Group's current liabilities have increased over the last five years to 37% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 9.4%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

In Conclusion...

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. However, total returns to shareholders over the last three years have been flat, which could indicate these growth trends potentially aren't accounted for yet by investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

One more thing: We've identified 3 warning signs with Wah Fu Education Group (at least 2 which shouldn't be ignored) , and understanding them would certainly be useful.

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.