Lions Gate Entertainment (NYSE:LGF.A) Has Some Difficulty Using Its Capital Effectively

What financial metrics can indicate to us that a company is maturing or even in decline? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. On that note, looking into Lions Gate Entertainment (NYSE:LGF.A), we weren't too upbeat about how things were going.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Lions Gate Entertainment:

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

0.0019 = US$13m ÷ (US$9.1b - US$2.3b) (Based on the trailing twelve months to June 2022).

Thus, Lions Gate Entertainment has an ROCE of 0.2%. Ultimately, that's a low return and it under-performs the Entertainment industry average of 5.1%.

Check out our latest analysis for Lions Gate Entertainment

In the above chart we have measured Lions Gate Entertainment's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Lions Gate Entertainment here for free.

What The Trend Of ROCE Can Tell Us

We are a bit worried about the trend of returns on capital at Lions Gate Entertainment. Unfortunately the returns on capital have diminished from the 2.8% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Lions Gate Entertainment becoming one if things continue as they have.

On a side note, Lions Gate Entertainment's current liabilities have increased over the last five years to 26% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 0.2%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

The Bottom Line

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Long term shareholders who've owned the stock over the last five years have experienced a 66% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you want to continue researching Lions Gate Entertainment, you might be interested to know about the 1 warning sign that our analysis has discovered.

While Lions Gate Entertainment may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.