iQIYI's (NASDAQ:IQ) Returns On Capital Are Heading Higher

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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. With that in mind, we've noticed some promising trends at iQIYI (NASDAQ:IQ) so let's look a bit deeper.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for iQIYI, this is the formula:

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

0.14 = CN¥3.1b ÷ (CN¥44b - CN¥23b) (Based on the trailing twelve months to September 2023).

Therefore, iQIYI has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Entertainment industry average of 9.6% it's much better.

Check out our latest analysis for iQIYI

Above you can see how the current ROCE for iQIYI 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 iQIYI.

The Trend Of ROCE

Shareholders will be relieved that iQIYI has broken into profitability. The company now earns 14% on its capital, because five years ago it was incurring losses. While returns have increased, the amount of capital employed by iQIYI has remained flat over the period. With no noticeable increase in capital employed, it's worth knowing what the company plans on doing going forward in regards to reinvesting and growing the business. So if you're looking for high growth, you'll want to see a business's capital employed also increasing.

Another thing to note, iQIYI has a high ratio of current liabilities to total assets of 51%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On iQIYI's ROCE

In summary, we're delighted to see that iQIYI has been able to increase efficiencies and earn higher rates of return on the same amount of capital. However the stock is down a substantial 73% in the last five years so there could be other areas of the business hurting its prospects. In any case, we believe the economic trends of this company are positive and looking into the stock further could prove rewarding.

Like most companies, iQIYI does come with some risks, and we've found 3 warning signs that you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and 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.