Warner Music Group's (NASDAQ:WMG) Returns On Capital Are Heading Higher

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. 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.

Return On Capital Employed (ROCE): What is it?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed 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$667m ÷ (US$7.8b - US$3.1b) (Based on the trailing twelve months to March 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 10% it's much better.

Check out our latest analysis for Warner Music Group

In the above chart we have measured Warner Music Group'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 Warner Music Group.

What Does the ROCE Trend For Warner Music Group 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 14%. The amount of capital employed has increased too, by 35%. 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.

Another thing to note, Warner Music Group has a high ratio of current liabilities to total assets of 40%. 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

To sum it up, Warner Music Group has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And since the stock has fallen 15% over the last year, there might be an opportunity here. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

Warner Music Group does have some risks, we noticed 4 warning signs (and 1 which is potentially serious) we think you should know about.

While Warner Music Group 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.