Here's What's Concerning About GungHo Online Entertainment's (TSE:3765) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at GungHo Online Entertainment (TSE:3765) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is 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. Analysts use this formula to calculate it for GungHo Online Entertainment:

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

0.15 = JP¥23b ÷ (JP¥171b - JP¥18b) (Based on the trailing twelve months to June 2024).

Therefore, GungHo Online Entertainment has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 11% generated by the Entertainment industry.

View our latest analysis for GungHo Online Entertainment

Above you can see how the current ROCE for GungHo Online Entertainment compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering GungHo Online Entertainment for free.

How Are Returns Trending?

On the surface, the trend of ROCE at GungHo Online Entertainment doesn't inspire confidence. Around five years ago the returns on capital were 40%, but since then they've fallen to 15%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

In Conclusion...

We're a bit apprehensive about GungHo Online Entertainment because despite more capital being deployed in the business, returns on that capital and sales have both fallen. However the stock has delivered a 44% return to shareholders over the last five years, so investors might be expecting the trends to turn around. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

On a separate note, we've found 1 warning sign for GungHo Online Entertainment 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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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.