Franklin Wireless (NASDAQ:FKWL) Might Be Having Difficulty Using Its Capital Effectively

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. In light of that, when we looked at Franklin Wireless (NASDAQ:FKWL) and its ROCE trend, we weren't exactly thrilled.

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. Analysts use this formula to calculate it for Franklin Wireless:

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

0.035 = US$1.5m ÷ (US$49m - US$5.2m) (Based on the trailing twelve months to December 2021).

So, Franklin Wireless has an ROCE of 3.5%. Ultimately, that's a low return and it under-performs the Communications industry average of 7.2%.

Check out our latest analysis for Franklin Wireless

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

How Are Returns Trending?

When we looked at the ROCE trend at Franklin Wireless, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 3.5% from 10% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Franklin Wireless has decreased its current liabilities to 10% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Franklin Wireless' ROCE

We're a bit apprehensive about Franklin Wireless because despite more capital being deployed in the business, returns on that capital and sales have both fallen. However the stock has delivered a 59% return to shareholders over the last five years, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Like most companies, Franklin Wireless does come with some risks, and we've found 3 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.

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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.