Investors Could Be Concerned With DEAG Deutsche Entertainment's (HMSE:LOU) Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at DEAG Deutsche Entertainment (HMSE:LOU) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. Analysts use this formula to calculate it for DEAG Deutsche Entertainment:

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

0.039 = €3.4m ÷ (€266m - €180m) (Based on the trailing twelve months to December 2022).

Thus, DEAG Deutsche Entertainment has an ROCE of 3.9%. Ultimately, that's a low return and it under-performs the Entertainment industry average of 15%.

See our latest analysis for DEAG Deutsche Entertainment

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how DEAG Deutsche Entertainment has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

SWOT Analysis for DEAG Deutsche Entertainment

The Trend Of ROCE

In terms of DEAG Deutsche Entertainment's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 20% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, DEAG Deutsche Entertainment has decreased its current liabilities to 68% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 68% is still pretty high, so those risks are still somewhat prevalent.

What We Can Learn From DEAG Deutsche Entertainment's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that DEAG Deutsche Entertainment is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 0.8% gain to shareholders who've held over the last year. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

DEAG Deutsche Entertainment does have some risks though, and we've spotted 3 warning signs for DEAG Deutsche Entertainment that you might be interested in.

While DEAG Deutsche Entertainment 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.