Kunlun Tech (SZSE:300418) Might Be Having Difficulty Using Its Capital Effectively

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don't think Kunlun Tech (SZSE:300418) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Kunlun Tech:

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

0.03 = CN¥507m ÷ (CN¥20b - CN¥3.0b) (Based on the trailing twelve months to September 2023).

Therefore, Kunlun Tech has an ROCE of 3.0%. In absolute terms, that's a low return and it also under-performs the Entertainment industry average of 4.4%.

Check out our latest analysis for Kunlun Tech

Above you can see how the current ROCE for Kunlun Tech compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Kunlun Tech for free.

What Can We Tell From Kunlun Tech's ROCE Trend?

On the surface, the trend of ROCE at Kunlun Tech doesn't inspire confidence. To be more specific, ROCE has fallen from 14% over the last five years. However it looks like Kunlun Tech might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

Our Take On Kunlun Tech's ROCE

In summary, Kunlun Tech is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Yet to long term shareholders the stock has gifted them an incredible 192% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

Kunlun Tech does have some risks, we noticed 3 warning signs (and 1 which is a bit concerning) we think you should know about.

While Kunlun Tech may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.