Be Wary Of CD Projekt (WSE:CDR) And Its Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think CD Projekt (WSE:CDR) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. To calculate this metric for CD Projekt, this is the formula:

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

0.15 = zł283m ÷ (zł2.2b - zł261m) (Based on the trailing twelve months to June 2022).

So, CD Projekt has an ROCE of 15%. In isolation, that's a pretty standard return but against the Entertainment industry average of 22%, it's not as good.

See our latest analysis for CD Projekt

Above you can see how the current ROCE for CD Projekt compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for CD Projekt.

So How Is CD Projekt's ROCE Trending?

On the surface, the trend of ROCE at CD Projekt doesn't inspire confidence. Around five years ago the returns on capital were 35%, but since then they've fallen to 15%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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.

In Conclusion...

In summary, we're somewhat concerned by CD Projekt's diminishing returns on increasing amounts of capital. Investors must expect better things on the horizon though because the stock has risen 24% in the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

One more thing to note, we've identified 2 warning signs with CD Projekt and understanding these should be part of your investment process.

While CD Projekt isn't earning the highest return, check out this free list of companies that are 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.