Returns On Capital Signal Tricky Times Ahead For NetEase (NASDAQ:NTES)

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at NetEase (NASDAQ:NTES) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What Is It?

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. The formula for this calculation on NetEase is:

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 December 2022).

Thus, NetEase has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 9.3% generated by the Entertainment industry.

Check out 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.

The Trend Of ROCE

In terms of NetEase's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 27% 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. If these investments prove successful, this can bode very well for long term stock performance.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that NetEase is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 42% over the last five years, it would appear that investors are upbeat about the future. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

If you'd like to know about the risks facing NetEase, we've discovered 1 warning sign that you should be aware of.

While NetEase isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.