Returns On Capital At SM Entertainment (KOSDAQ:041510) Paint A Concerning Picture

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at SM Entertainment (KOSDAQ:041510), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What is it?

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. The formula for this calculation on SM Entertainment is:

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

0.007 = ₩4.5b ÷ (₩1.1t - ₩434b) (Based on the trailing twelve months to December 2020).

So, SM Entertainment has an ROCE of 0.7%. Ultimately, that's a low return and it under-performs the Entertainment industry average of 8.7%.

See our latest analysis for SM Entertainment

Above you can see how the current ROCE for SM Entertainment compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What The Trend Of ROCE Can Tell Us

In terms of SM Entertainment's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 9.5% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. 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.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 41%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Bottom Line

In summary, we're somewhat concerned by SM Entertainment's diminishing returns on increasing amounts of capital. It should come as no surprise then that the stock has fallen 24% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

If you're still interested in SM Entertainment it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.

While SM Entertainment 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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