Perfect World (SZSE:002624) Will Be Looking To Turn Around Its Returns

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This indicates the company is producing less profit from its investments and its total assets are decreasing. So after glancing at the trends within Perfect World (SZSE:002624), we weren't too hopeful.

Understanding 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. Analysts use this formula to calculate it for Perfect World:

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).

Thus, Perfect World has an ROCE of 5.0%. In absolute terms, that's a low return but it's around the Entertainment industry average of 4.4%.

View our latest analysis for Perfect World

Above you can see how the current ROCE for Perfect World compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Perfect World .

What Does the ROCE Trend For Perfect World Tell Us?

There is reason to be cautious about Perfect World, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 16% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Perfect World to turn into a multi-bagger.

The Key Takeaway

In summary, it's unfortunate that Perfect World is generating lower returns from the same amount of capital. Long term shareholders who've owned the stock over the last five years have experienced a 33% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One more thing: We've identified 3 warning signs with Perfect World (at least 1 which can't be ignored) , and understanding them would certainly be useful.

While Perfect World 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.