Spotify Technology (NYSE:SPOT) Might Have The Makings Of A Multi-Bagger

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at Spotify Technology (NYSE:SPOT) and its trend of ROCE, we really liked what we saw.

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. To calculate this metric for Spotify Technology, this is the formula:

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

0.047 = €242m ÷ (€9.1b - €4.0b) (Based on the trailing twelve months to March 2024).

So, Spotify Technology has an ROCE of 4.7%. Ultimately, that's a low return and it under-performs the Entertainment industry average of 8.8%.

View our latest analysis for Spotify Technology

Above you can see how the current ROCE for Spotify Technology 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 analyst report for Spotify Technology .

What The Trend Of ROCE Can Tell Us

We're delighted to see that Spotify Technology is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses five years ago, but now it's earning 4.7% which is a sight for sore eyes. In addition to that, Spotify Technology is employing 66% more capital than previously which is expected of a company that's trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

On a separate but related note, it's important to know that Spotify Technology has a current liabilities to total assets ratio of 44%, which we'd consider pretty high. 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 Key Takeaway

Overall, Spotify Technology gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

On a final note, we've found 1 warning sign for Spotify Technology that we think you should be aware of.

While Spotify Technology 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.