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

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. With that in mind, we've noticed some promising trends at iQIYI (NASDAQ:IQ) so let's look a bit deeper.

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 iQIYI, this is the formula:

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

0.11 = CN¥2.6b ÷ (CN¥45b - CN¥21b) (Based on the trailing twelve months to September 2024).

Therefore, iQIYI has an ROCE of 11%. That's a relatively normal return on capital, and it's around the 9.9% generated by the Entertainment industry.

View 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, you can check out the forecasts from the analysts covering iQIYI for free.

What Can We Tell From iQIYI's ROCE Trend?

Shareholders will be relieved that iQIYI has broken into profitability. While the business was unprofitable in the past, it's now turned things around and is earning 11% on its capital. Interestingly, the capital employed by the business has remained relatively flat, so these higher returns are either from prior investments paying off or increased efficiencies. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. Because in the end, a business can only get so efficient.

Another thing to note, iQIYI has a high ratio of current liabilities to total assets of 48%. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

As discussed above, iQIYI appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And since the stock has dived 91% over the last five years, there may be other factors affecting the company's prospects. Regardless, we think the underlying fundamentals warrant this stock for further investigation.

One more thing to note, we've identified 1 warning sign with iQIYI and understanding it should be part of your investment process.

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.