Why You Should Care About Universal Music Group's (AMS:UMG) Strong Returns On Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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. 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.

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

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

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

0.23 = €1.6b ÷ (€13b - €6.0b) (Based on the trailing twelve months to December 2022).

Thus, Universal Music Group has an ROCE of 23%. That's a fantastic return and not only that, it outpaces the average of 13% earned by companies in a similar industry.

View 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 here for free.

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

In terms of Universal Music Group's history of ROCE, it's quite impressive. Over the past three years, ROCE has remained relatively flat at around 23% and the business has deployed 51% more capital into its operations. With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.

On a separate but related note, it's important to know that Universal Music Group has a current liabilities to total assets ratio of 46%, 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.

The Bottom Line On Universal Music Group's ROCE

In the end, the company has proven it can reinvest it's capital at high rates of returns, which you'll remember is a trait of a multi-bagger. However, over the last year, the stock hasn't provided much growth to shareholders in the way of total returns. For that reason, savvy investors might want to look further into this company in case it's a prime investment.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Universal Music Group (of which 1 doesn't sit too well with us!) that you should know about.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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.