When researching a stock for investment, what can tell us that the company is in decline? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. So after we looked into Perfect World (SZSE:002624), the trends above didn't look too great.
What Is Return On Capital Employed (ROCE)?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Perfect World, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.05 = CN¥570m ÷ (CN¥15b - CN¥3.5b) (Based on the trailing twelve months to September 2023).
So, Perfect World has an ROCE of 5.0%. On its own, that's a low figure but it's around the 4.5% average generated by the Entertainment industry.
In the above chart we have measured Perfect World's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Perfect World .
What The Trend Of ROCE Can Tell Us
There is reason to be cautious about Perfect World, given the returns are trending downwards. To be more specific, the ROCE was 16% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Perfect World to turn into a multi-bagger.
The Bottom Line On Perfect World's ROCE
In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Investors haven't taken kindly to these developments, since the stock has declined 41% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
If you want to know some of the risks facing Perfect World we've found 3 warning signs (1 is potentially serious!) that you should be aware of before investing here.
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.