What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at iDreamSky Technology Holdings (HKG:1119), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on iDreamSky Technology Holdings is:

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

0.01 = CN¥51m ÷ (CN¥6.6b - CN¥1.5b) (Based on the trailing twelve months to December 2021).

Therefore, iDreamSky Technology Holdings has an ROCE of 1.0%. Ultimately, that's a low return and it under-performs the Entertainment industry average of 7.0%.

Check out our latest analysis for iDreamSky Technology Holdings

In the above chart we have measured iDreamSky Technology Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering iDreamSky Technology Holdings here for free.

So How Is iDreamSky Technology Holdings' ROCE Trending?

On the surface, the trend of ROCE at iDreamSky Technology Holdings doesn't inspire confidence. To be more specific, ROCE has fallen from 10.0% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, iDreamSky Technology Holdings has done well to pay down its current liabilities to 23% of total assets. Since the ratio used to be 73%, that's a significant reduction and it no doubt explains the drop in ROCE. 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

Our Take On iDreamSky Technology Holdings' ROCE

In summary, we're somewhat concerned by iDreamSky Technology Holdings' diminishing returns on increasing amounts of capital. It should come as no surprise then that the stock has fallen 15% over the last three years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a separate note, we've found 3 warning signs for iDreamSky Technology Holdings you'll probably want to know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.