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

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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating iDreamSky Technology Holdings (HKG:1119), we don't think it's current trends fit the mold of a multi-bagger.

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 iDreamSky Technology Holdings:

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

0.016 = CN¥68m ÷ (CN¥6.4b - CN¥2.1b) (Based on the trailing twelve months to June 2021).

So, iDreamSky Technology Holdings has an ROCE of 1.6%. Ultimately, that's a low return and it under-performs the Entertainment industry average of 11%.

Check out 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. Over the last five years, returns on capital have decreased to 1.6% from 20% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, iDreamSky Technology Holdings has done well to pay down its current liabilities to 33% of total assets. So we could link some of this to the decrease 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From iDreamSky Technology Holdings' ROCE

To conclude, we've found that iDreamSky Technology Holdings is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 70% over the last year, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

iDreamSky Technology Holdings does have some risks, we noticed 3 warning signs (and 1 which is a bit unpleasant) we think you should know about.

While iDreamSky Technology Holdings isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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.

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