Capital Allocation Trends At Paradox Interactive (STO:PDX) Aren't Ideal

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. So when we looked at Paradox Interactive (STO:PDX), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

What Is Return On Capital Employed (ROCE)?

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 Paradox Interactive is:

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

0.24 = kr673m ÷ (kr3.2b - kr470m) (Based on the trailing twelve months to September 2024).

Therefore, Paradox Interactive has an ROCE of 24%. 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 Paradox Interactive

In the above chart we have measured Paradox Interactive's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Paradox Interactive for free.

What Does the ROCE Trend For Paradox Interactive Tell Us?

When we looked at the ROCE trend at Paradox Interactive, we didn't gain much confidence. Historically returns on capital were even higher at 43%, but they have dropped over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

The Bottom Line

While returns have fallen for Paradox Interactive in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These trends are starting to be recognized by investors since the stock has delivered a 37% gain to shareholders who've held over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

One more thing, we've spotted 2 warning signs facing Paradox Interactive that you might find interesting.

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.