Here's What's Concerning About iDreamSky Technology Holdings' (HKG:1119) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at iDreamSky Technology Holdings (HKG:1119) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for iDreamSky Technology Holdings, this is the formula:

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

0.01 = CN¥51m ÷ (CN¥6.6b - CN¥1.5b) (Based on the trailing twelve months to December 2021).

Therefore, iDreamSky Technology Holdings has an ROCE of 1.0%. Ultimately, that's a low return and it under-performs the Entertainment industry average of 8.7%.

View our latest analysis for iDreamSky Technology Holdings

In the above chart we have measured iDreamSky Technology Holdings' 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.

How Are Returns Trending?

When we looked at the ROCE trend at iDreamSky Technology Holdings, we didn't gain much confidence. To be more specific, ROCE has fallen from 10.0% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, iDreamSky Technology Holdings has done well to pay down its current liabilities to 23% of total assets. Since the ratio used to be 73%, that's a significant reduction and it no doubt explains the drop in ROCE. 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From iDreamSky Technology Holdings' ROCE

In summary, we're somewhat concerned by iDreamSky Technology Holdings' diminishing returns on increasing amounts of capital. And, the stock has remained flat over the last three years, so investors don't seem too impressed either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

iDreamSky Technology Holdings does have some risks though, and we've spotted 1 warning sign for iDreamSky Technology Holdings that you might be interested in.

While iDreamSky Technology Holdings 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.