What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. With that in mind, we've noticed some promising trends at Cloud Music (HKG:9899) so let's look a bit deeper.
Understanding 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. To calculate this metric for Cloud Music, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.039 = CN¥332m ÷ (CN¥12b - CN¥3.1b) (Based on the trailing twelve months to December 2023).
Thus, Cloud Music has an ROCE of 3.9%. In absolute terms, that's a low return and it also under-performs the Entertainment industry average of 6.2%.
In the above chart we have measured Cloud Music's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Cloud Music .
So How Is Cloud Music's ROCE Trending?
The fact that Cloud Music is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 3.9% on its capital. Not only that, but the company is utilizing 103% more capital than before, but that's to be expected from a company trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.
On a related note, the company's ratio of current liabilities to total assets has decreased to 27%, which basically reduces it's funding from the likes of short-term creditors or suppliers. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.
Our Take On Cloud Music's ROCE
Long story short, we're delighted to see that Cloud Music's reinvestment activities have paid off and the company is now profitable. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 19% return over the last year. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
Before jumping to any conclusions though, we need to know what value we're getting for the current share price. That's where you can check out our FREE intrinsic value estimation for 9899 that compares the share price and estimated value.
While Cloud Music isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.