Be Wary Of YG Entertainment (KOSDAQ:122870) And Its Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. Having said that, from a first glance at YG Entertainment (KOSDAQ:122870) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. The formula for this calculation on YG Entertainment is:

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

0.008 = ₩4.8b ÷ (₩727b - ₩128b) (Based on the trailing twelve months to June 2024).

Thus, YG Entertainment has an ROCE of 0.8%. Ultimately, that's a low return and it under-performs the Entertainment industry average of 7.2%.

Check out our latest analysis for YG Entertainment

Above you can see how the current ROCE for YG 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 YG Entertainment for free.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at YG Entertainment, we didn't gain much confidence. To be more specific, ROCE has fallen from 2.7% 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.

The Bottom Line On YG Entertainment's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for YG Entertainment have fallen, meanwhile the business is employing more capital than it was five years ago. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 94% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you'd like to know about the risks facing YG Entertainment, we've discovered 2 warning signs that you should be aware of.

While YG Entertainment may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.