Our Take On The Returns On Capital At iDreamSky Technology Holdings (HKG:1119)

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look 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. 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.

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. The formula for this calculation on iDreamSky Technology Holdings is:

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

0.088 = CN¥458m ÷ (CN¥6.9b - CN¥1.7b) (Based on the trailing twelve months to June 2020).

So, iDreamSky Technology Holdings has an ROCE of 8.8%. In absolute terms, that's a low return and it also under-performs the Entertainment industry average of 14%.

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'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?

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 20% over the last four years. 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, iDreamSky Technology Holdings has done well to pay down its current liabilities to 25% 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. 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.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by iDreamSky Technology Holdings' reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 3.5% over the last year, which potentially indicates that investors are accounting for this going forward. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

One more thing, we've spotted 1 warning sign facing iDreamSky Technology Holdings that you might find interesting.

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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.
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