Paradox Interactive (STO:PDX) May Have Issues Allocating Its Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Looking at Paradox Interactive (STO:PDX), it does have a high ROCE right now, but lets see how returns are trending.

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. Analysts use this formula to calculate it for Paradox Interactive:

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

0.30 = kr843m ÷ (kr3.6b - kr740m) (Based on the trailing twelve months to December 2023).

Thus, Paradox Interactive has an ROCE of 30%. In absolute terms that's a great return and it's even better than the Entertainment industry average of 5.9%.

See our latest analysis for Paradox Interactive

Above you can see how the current ROCE for Paradox Interactive 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 Paradox Interactive for free.

What Does the ROCE Trend For Paradox Interactive Tell Us?

In terms of Paradox Interactive's historical ROCE movements, the trend isn't fantastic. Historically returns on capital were even higher at 46%, but they have dropped over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

Our Take On Paradox Interactive's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Paradox Interactive is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 31% gain to shareholders who've held over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

One more thing, we've spotted 3 warning signs facing Paradox Interactive that you might find interesting.

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.

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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.