Here's What's Concerning About NCSOFT's (KRX:036570) Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at NCSOFT (KRX:036570) 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. Analysts use this formula to calculate it for NCSOFT:

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

0.015 = ₩55b ÷ (₩4.2t - ₩447b) (Based on the trailing twelve months to June 2024).

Thus, NCSOFT has an ROCE of 1.5%. In absolute terms, that's a low return and it also under-performs the Entertainment industry average of 6.7%.

View our latest analysis for NCSOFT

In the above chart we have measured NCSOFT'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 NCSOFT for free.

How Are Returns Trending?

On the surface, the trend of ROCE at NCSOFT doesn't inspire confidence. Around five years ago the returns on capital were 16%, but since then they've fallen to 1.5%. 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.

What We Can Learn From NCSOFT's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for NCSOFT have fallen, meanwhile the business is employing more capital than it was five years ago. It should come as no surprise then that the stock has fallen 54% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

On a separate note, we've found 1 warning sign for NCSOFT 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.