What Do The Returns On Capital At iDreamSky Technology Holdings (HKG:1119) Tell Us?

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

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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)

0.088 = 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%. Ultimately, that's a low return and it 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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

So How Is iDreamSky Technology Holdings' ROCE Trending?

In terms of iDreamSky Technology Holdings' historical ROCE movements, the trend isn't fantastic. Over the last four years, returns on capital have decreased to 8.8% from 20% four years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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 25% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On iDreamSky Technology Holdings' ROCE

In summary, iDreamSky Technology Holdings is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has declined 14% over the last year, investors may not be too optimistic on this trend improving either. Therefore based on the analysis done in this article, we don't think iDreamSky Technology Holdings has the makings of a multi-bagger.

On a separate note, we've found 2 warning signs for iDreamSky Technology Holdings you'll probably want to know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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