Universal Music Group (AMS:UMG) Knows How To Allocate Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, the ROCE of Universal Music Group (AMS:UMG) looks attractive right now, so lets see what the trend of returns can tell us.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Universal Music Group, this is the formula:

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

0.21 = €1.7b ÷ (€15b - €7.2b) (Based on the trailing twelve months to June 2024).

Therefore, 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 16%.

See our latest analysis for Universal Music Group

Above you can see how the current ROCE for Universal Music Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Universal Music Group for free.

What Can We Tell From Universal Music Group's ROCE Trend?

We'd be pretty happy with returns on capital like Universal Music Group. The company has consistently earned 21% for the last five years, and the capital employed within the business has risen 71% in that time. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.

Another thing to note, Universal Music Group has a high ratio of current liabilities to total assets of 47%. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

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. And since the stock has risen strongly over the last three years, it appears the market might expect this trend to continue. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

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.

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.