Spotify Technology (NYSE:SPOT) Shareholders Will Want The ROCE Trajectory To Continue

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)

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. Analysts use this formula to calculate it for Spotify Technology:

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

0.024 = €96m ÷ (€7.2b - €3.2b) (Based on the trailing twelve months to December 2021).

Thus, Spotify Technology has an ROCE of 2.4%. In absolute terms, that's a low return and it also under-performs the Entertainment industry average of 10%.

See our latest analysis for Spotify Technology

In the above chart we have measured Spotify Technology'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 Spotify Technology here for free.

What Can We Tell From Spotify Technology's ROCE Trend?

We're delighted to see that Spotify Technology is reaping rewards from its investments and is now generating some pre-tax profits. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 2.4% on its capital. Not only that, but the company is utilizing 348% more capital than before, but that's to be expected from a company 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.

In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 45%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. This tells us that Spotify Technology has grown its returns without a reliance on increasing their current liabilities, which we're very happy with. However, current liabilities are still at a pretty high level, so just be aware that this can bring with it some risks.

In Conclusion...

In summary, it's great to see that Spotify Technology has managed to break into profitability and is continuing to reinvest in its business. Investors may not be impressed by the favorable underlying trends yet because over the last three years the stock has only returned 0.7% to shareholders. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.

Spotify Technology does have some risks though, and we've spotted 1 warning sign for Spotify Technology that you might be interested in.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.