Here's What To Make Of African Media Entertainment's (JSE:AME) Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating African Media Entertainment (JSE:AME), we don't think it's current trends fit the mold of a multi-bagger.

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. To calculate this metric for African Media Entertainment, this is the formula:

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

0.13 = R34m ÷ (R306m - R45m) (Based on the trailing twelve months to September 2020).

Therefore, African Media Entertainment has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Media industry average of 8.9% it's much better.

Check out our latest analysis for African Media Entertainment

Historical performance is a great place to start when researching a stock so above you can see the gauge for African Media Entertainment's ROCE against it's prior returns. If you'd like to look at how African Media Entertainment has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From African Media Entertainment's ROCE Trend?

On the surface, the trend of ROCE at African Media Entertainment doesn't inspire confidence. Around five years ago the returns on capital were 35%, but since then they've fallen to 13%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, African Media Entertainment has decreased its current liabilities to 15% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line On African Media Entertainment's ROCE

We're a bit apprehensive about African Media Entertainment because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Investors haven't taken kindly to these developments, since the stock has declined 69% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One more thing: We've identified 4 warning signs with African Media Entertainment (at least 1 which can't be ignored) , and understanding these would certainly be useful.

While African Media Entertainment 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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