Medialink Group (HKG:2230) Might Be Having Difficulty Using Its Capital Effectively

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Medialink Group (HKG:2230) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Medialink Group, this is the formula:

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

0.10 = HK$53m ÷ (HK$762m - HK$250m) (Based on the trailing twelve months to March 2021).

Therefore, Medialink Group has an ROCE of 10%. That's a relatively normal return on capital, and it's around the 9.2% generated by the Interactive Media and Services industry.

View our latest analysis for Medialink Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for Medialink Group's ROCE against it's prior returns. If you'd like to look at how Medialink Group has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Medialink Group's ROCE Trending?

On the surface, the trend of ROCE at Medialink Group doesn't inspire confidence. Over the last five years, returns on capital have decreased to 10% from 43% five 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, Medialink Group 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.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Medialink Group's reinvestment in its own business, we're aware that returns are shrinking. Although the market must be expecting these trends to improve because the stock has gained 89% over the last year. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

If you'd like to know more about Medialink Group, we've spotted 5 warning signs, and 1 of them can't be ignored.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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