Investors Will Want Warner Music Group's (NASDAQ:WMG) Growth In ROCE To Persist

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So on that note, Warner Music Group (NASDAQ:WMG) looks quite promising in regards to its trends of return on capital.

What Is 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. The formula for this calculation on Warner Music Group is:

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

0.15 = US$735m ÷ (US$8.2b - US$3.3b) (Based on the trailing twelve months to June 2023).

Thus, Warner Music Group has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Entertainment industry average of 9.1% it's much better.

Check out our latest analysis for Warner Music Group

Above you can see how the current ROCE for Warner Music Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What The Trend Of ROCE Can Tell Us

We like the trends that we're seeing from Warner Music Group. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 15%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 40%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

On a side note, Warner Music Group's current liabilities are still rather high at 40% of total assets. 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.

What We Can Learn From Warner Music Group's ROCE

All in all, it's terrific to see that Warner Music Group is reaping the rewards from prior investments and is growing its capital base. Considering the stock has delivered 17% to its stockholders over the last three years, it may be fair to think that investors aren't fully aware of the promising trends yet. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Warner Music Group (of which 1 doesn't sit too well with us!) that you should know about.

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.