iDreamSky Technology Holdings (HKG:1119) Is Reinvesting At Lower Rates Of Return

There are a few key trends to look for if we want to identify the next multi-bagger. 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think iDreamSky Technology Holdings (HKG:1119) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is Return On Capital Employed (ROCE)?

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. 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)

0.068 = CN¥292m ÷ (CN¥6.8b - CN¥2.4b) (Based on the trailing twelve months to December 2020).

Therefore, iDreamSky Technology Holdings has an ROCE of 6.8%. In absolute terms, that's a low return and it also under-performs the Entertainment industry average of 15%.

See 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'd like to see what analysts are forecasting going forward, you should check out our free report for iDreamSky Technology Holdings.

What Can We Tell From iDreamSky Technology Holdings' ROCE Trend?

On the surface, the trend of ROCE at iDreamSky Technology Holdings doesn't inspire confidence. Around five years ago the returns on capital were 35%, but since then they've fallen to 6.8%. 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, iDreamSky Technology Holdings has decreased its current liabilities to 36% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.

The Bottom Line On iDreamSky Technology Holdings' ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for iDreamSky Technology Holdings. In light of this, the stock has only gained 0.6% over the last year. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

iDreamSky Technology Holdings does have some risks, we noticed 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.

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.

If you’re looking to trade a wide range of investments, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.