We're Watching These Trends At Kakao (KRX:035720)

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. Having said that, from a first glance at Kakao (KRX:035720) 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 Kakao:

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

0.043 = ₩384b ÷ (₩11t - ₩2.3t) (Based on the trailing twelve months to September 2020).

Therefore, Kakao has an ROCE of 4.3%. Ultimately, that's a low return and it under-performs the Interactive Media and Services industry average of 14%.

See our latest analysis for Kakao

Above you can see how the current ROCE for Kakao 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 Does the ROCE Trend For Kakao Tell Us?

There are better returns on capital out there than what we're seeing at Kakao. The company has consistently earned 4.3% for the last five years, and the capital employed within the business has risen 235% in that time. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 21% of total assets, this reported ROCE would probably be less than4.3% because total capital employed would be higher.The 4.3% ROCE could be even lower if current liabilities weren't 21% of total assets, because the the formula would show a larger base of total capital employed. With that in mind, just be wary if this ratio increases in the future, because if it gets particularly high, this brings with it some new elements of risk.

What We Can Learn From Kakao's ROCE

In conclusion, Kakao has been investing more capital into the business, but returns on that capital haven't increased. Yet to long term shareholders the stock has gifted them an incredible 433% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Like most companies, Kakao does come with some risks, and we've found 2 warning signs that you should be aware of.

While Kakao 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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