If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. So when we looked at Warner Music Group (NASDAQ:WMG) and its trend of ROCE, we really liked what we saw.
Return On Capital Employed (ROCE): What Is It?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Warner Music Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.18 = US$942m ÷ (US$9.0b - US$3.7b) (Based on the trailing twelve months to December 2023).
So, Warner Music Group has an ROCE of 18%. In absolute terms, that's a satisfactory return, but compared to the Entertainment industry average of 11% it's much better.
In the above chart we have measured Warner Music Group'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 Warner Music Group .
What Does the ROCE Trend For Warner Music Group Tell Us?
Warner Music Group is displaying some positive trends. Over the last five years, returns on capital employed have risen substantially to 18%. The amount of capital employed has increased too, by 56%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
On a separate but related note, it's important to know that Warner Music Group has a current liabilities to total assets ratio of 42%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
In Conclusion...
In summary, it's great to see that Warner Music Group can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Since the total return from the stock has been almost flat over the last three years, there might be an opportunity here if the valuation looks good. That being the case, research into the company's current valuation metrics and future prospects seems fitting.
If you'd like to know more about Warner Music Group, we've spotted 3 warning signs, and 1 of them can't be ignored.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.