Many Would Be Envious Of Universal Music Group's (AMS:UMG) Excellent Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. So, when we ran our eye over Universal Music Group's (AMS:UMG) trend of ROCE, we really liked what we saw.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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)

0.21 = €1.5b ÷ (€13b - €6.0b) (Based on the trailing twelve months to June 2022).

Thus, Universal Music Group has an ROCE of 21%. In absolute terms that's a great return and it's even better than the Entertainment industry average of 13%.

Our analysis indicates that UMG is potentially overvalued!

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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For Universal Music Group Tell Us?

We'd be pretty happy with returns on capital like Universal Music Group. Over the past three years, ROCE has remained relatively flat at around 21% and the business has deployed 51% more capital into its operations. Now considering ROCE is an attractive 21%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.

On a side note, Universal Music Group's current liabilities are still rather high at 46% of total assets. 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.

What We Can Learn From 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. Yet over the last year the stock has declined 15%, so the decline might provide an opening. For that reason, savvy investors might want to look further into this company in case it's a prime investment.

On a final note, we've found 3 warning signs for Universal Music Group that we think you should be aware of.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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.