PlaySide Studios' (ASX:PLY) Returns Have Hit A Wall

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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 ran our eye over PlaySide Studios' (ASX:PLY) trend of ROCE, we liked what we saw.

Return On Capital Employed (ROCE): What Is It?

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. Analysts use this formula to calculate it for PlaySide Studios:

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

0.12 = AU$5.7m ÷ (AU$55m - AU$7.9m) (Based on the trailing twelve months to June 2022).

So, PlaySide Studios has an ROCE of 12%. That's a relatively normal return on capital, and it's around the 11% generated by the Entertainment industry.

Our analysis indicates that PLY is potentially undervalued!

In the above chart we have measured PlaySide Studios' 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 report on analyst forecasts for the company.

The Trend Of ROCE

While the returns on capital are good, they haven't moved much. The company has employed 2,320% more capital in the last three years, and the returns on that capital have remained stable at 12%. Since 12% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.

On a side note, PlaySide Studios has done well to reduce current liabilities to 14% of total assets over the last three years. Effectively suppliers now fund less of the business, which can lower some elements of risk.

The Bottom Line

The main thing to remember is that PlaySide Studios has proven its ability to continually reinvest at respectable rates of return. And since the stock has risen strongly over the last year, it appears the market might expect this trend to continue. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

One final note, you should learn about the 2 warning signs we've spotted with PlaySide Studios (including 1 which makes us a bit uncomfortable) .

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.