Investors Could Be Concerned With 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. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. 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)

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)

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

So, iDreamSky Technology Holdings has an ROCE of 1.0%. In absolute terms, that's a low return and it also under-performs the Entertainment industry average of 6.0%.

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'd like, you can check out the forecasts from the analysts covering iDreamSky Technology Holdings here for free.

The Trend Of ROCE

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. Considering it used to be 73%, that's a huge drop in that ratio and it would explain the decline 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 Key Takeaway

We're a bit apprehensive about iDreamSky Technology Holdings because despite more capital being deployed in the business, returns on that capital and sales have both fallen. It should come as no surprise then that the stock has fallen 57% over the last three years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you want to continue researching iDreamSky Technology Holdings, you might be interested to know about the 2 warning signs that our analysis has discovered.

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.

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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.