If we are to find multi-bagger potential, there are often underlying trends that can provide clues. Among other things, we’ll want to see two things; first, a growth to recover on capital employed (ROCE) and on the other hand, an expansion of the amount capital employed. Put simply, these types of businesses are dialing machines, which means they continually reinvest their profits at ever higher rates of return. However, after briefly reviewing the numbers, we don’t think NetEase (NASDAQ: NTES) has the makings of a multi-bagger going forward, but let’s see why it may be.
What is Return on Employee Capital (ROCE)?
For those who don’t know, ROCE is a measure of a company’s annual pre-tax profit (its return), relative to the capital employed in the company. The formula for this calculation on NetEase is:
Return on capital employed = Profit before interest and taxes (EBIT) ÷ (Total assets – Current liabilities)
0.14 = CN ¥ 14b ÷ (CN ¥ 155b – CN ¥ 54b) (Based on the last twelve months up to June 2021).
Thereby, NetEase has a ROCE of 14%. On its own, that’s a standard return, but it’s way better than the 11% generated by the entertainment industry.
See our latest review for NetEase
In the graph above, we measured NetEase’s past ROCE against its past performance, but the future is arguably more important. If you like, you can view analyst forecasts covering NetEase here for free.
The ROCE trend
In terms of NetEase’s historic ROCE movements, the trend is not great. To be more precise, ROCE has increased from 32% over the past five years. However, as both capital employed and income have increased, it appears that the company is currently continuing to grow, resulting in short-term returns. If these investments prove to be successful, it can bode very well for stock performance in the long run.
The key to take away
Although returns on capital have declined in the short term, we find promise that both revenue and capital employed have increased for NetEase. And the stock followed suit, earning 83% to shareholders over the past five years. So if these growth trends continue, we would be optimistic about the future of the title.
On a final note, we found 2 warning signs for NetEase that we think you should be aware of.
If you want to look for solid businesses with great income, check out this free list of companies with good balance sheets and impressive returns on equity.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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