Be Wary Of Melco Resorts & Entertainment (NASDAQ:MLCO) And Its Returns On Capital

When researching a stock for investment, what can tell us that the company is in decline? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. And from a first read, things don't look too good at Melco Resorts & Entertainment (NASDAQ:MLCO), so let's see why.

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. To calculate this metric for Melco Resorts & Entertainment, this is the formula:

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

0.0089 = US$65m ÷ (US$8.4b - US$1.1b) (Based on the trailing twelve months to December 2023).

Therefore, Melco Resorts & Entertainment has an ROCE of 0.9%. In absolute terms, that's a low return and it also under-performs the Hospitality industry average of 9.6%.

Check out our latest analysis for Melco Resorts & Entertainment

In the above chart we have measured Melco Resorts & Entertainment'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 Melco Resorts & Entertainment for free.

What The Trend Of ROCE Can Tell Us

There is reason to be cautious about Melco Resorts & Entertainment, given the returns are trending downwards. About five years ago, returns on capital were 8.8%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Melco Resorts & Entertainment to turn into a multi-bagger.

On a related note, Melco Resorts & Entertainment has decreased its current liabilities to 13% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

Our Take On Melco Resorts & Entertainment's ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. It should come as no surprise then that the stock has fallen 67% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One more thing to note, we've identified 1 warning sign with Melco Resorts & Entertainment and understanding this should be part of your investment process.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.