Some Investors May Be Worried About YG Entertainment's (KOSDAQ:122870) 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. 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. 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 YG Entertainment (KOSDAQ:122870) and its ROCE trend, we weren't exactly thrilled.

What is 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. To calculate this metric for YG Entertainment, this is the formula:

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

0.013 = ₩5.8b ÷ (₩543b - ₩102b) (Based on the trailing twelve months to December 2020).

Therefore, YG Entertainment has an ROCE of 1.3%. Ultimately, that's a low return and it under-performs the Entertainment industry average of 8.7%.

Check out our latest analysis for YG Entertainment

In the above chart we have measured YG Entertainment's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering YG Entertainment here for free.

The Trend Of ROCE

In terms of YG Entertainment's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 6.6% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

The Bottom Line On YG Entertainment's ROCE

Bringing it all together, while we're somewhat encouraged by YG Entertainment's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 6.2% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

One more thing to note, we've identified 1 warning sign with YG Entertainment and understanding it should be part of your investment process.

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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This article by Simply Wall St is general in nature. 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.
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