NetEase (NASDAQ:NTES) Might Be Having Difficulty Using Its Capital Effectively

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. Although, when we looked at NetEase (NASDAQ:NTES), it didn't seem to tick all of these boxes.

Understanding 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 NetEase, this is the formula:

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

0.17 = CN¥20b ÷ (CN¥173b - CN¥57b) (Based on the trailing twelve months to September 2022).

Therefore, NetEase has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 8.7% generated by the Entertainment industry.

See our latest analysis for NetEase

In the above chart we have measured NetEase's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for NetEase.

What Can We Tell From NetEase's ROCE Trend?

When we looked at the ROCE trend at NetEase, we didn't gain much confidence. Around five years ago the returns on capital were 31%, but since then they've fallen to 17%. 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. If these investments prove successful, this can bode very well for long term stock performance.

Our Take On NetEase's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for NetEase. These trends are starting to be recognized by investors since the stock has delivered a 6.9% 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.

On a final note, we've found 1 warning sign for NetEase that we think you should be aware of.

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.