Investors Shouldn't Overlook The Favourable Returns On Capital At Universal Music Group (AMS:UMG)

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. That's why when we briefly looked at Universal Music Group's (AMS:UMG) ROCE trend, we were very happy with what we saw.

Return On Capital Employed (ROCE): What Is It?

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 Universal Music Group is:

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

0.24 = €1.5b ÷ (€12b - €6.2b) (Based on the trailing twelve months to June 2023).

Thus, Universal Music Group has an ROCE of 24%. In absolute terms that's a great return and it's even better than the Entertainment industry average of 13%.

See our latest analysis for Universal Music Group

In the above chart we have measured Universal Music Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Universal Music Group.

What The Trend Of ROCE Can Tell Us

We'd be pretty happy with returns on capital like Universal Music Group. The company has employed 34% more capital in the last four years, and the returns on that capital have remained stable at 24%. Now considering ROCE is an attractive 24%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns. If Universal Music Group can keep this up, we'd be very optimistic about its future.

On a separate but related note, it's important to know that Universal Music Group has a current liabilities to total assets ratio of 50%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

Our Take On Universal Music Group's ROCE

In short, we'd argue Universal Music Group has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. Therefore it's no surprise that shareholders have earned a respectable 17% return if they held over the last year. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.

On a separate note, we've found 1 warning sign for Universal Music Group you'll probably want to know about.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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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.