Warner Music Group (NASDAQ:WMG) Is Experiencing Growth In Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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 Warner Music Group (NASDAQ:WMG) so let's look a bit deeper.

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. To calculate this metric for Warner Music Group, this is the formula:

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

0.14 = US$651m ÷ (US$7.7b - US$3.1b) (Based on the trailing twelve months to June 2022).

Thus, Warner Music Group has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Entertainment industry average of 5.1% it's much better.

View 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'd like, you can check out the forecasts from the analysts covering Warner Music Group here for free.

What Can We Tell From Warner Music Group's ROCE Trend?

We like the trends that we're seeing from Warner Music Group. Over the last five years, returns on capital employed have risen substantially to 14%. 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 29%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

On a side note, Warner Music Group's current liabilities are still rather high at 41% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On Warner Music Group's ROCE

In summary, it's great to see that Warner Music Group can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Astute investors may have an opportunity here because the stock has declined 44% in the last year. With that in mind, we believe the promising trends warrant this stock for further investigation.

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 shouldn't be ignored!) 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.