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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in Tencent Music Entertainment Group's (NYSE:TME) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What is it?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Tencent Music Entertainment Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.071 = CN¥4.2b ÷ (CN¥68b - CN¥9.5b) (Based on the trailing twelve months to March 2021).
So, Tencent Music Entertainment Group has an ROCE of 7.1%. Ultimately, that's a low return and it under-performs the Entertainment industry average of 14%.
In the above chart we have measured Tencent Music Entertainment Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Tencent Music Entertainment Group.
The Trend Of ROCE
We're glad to see that ROCE is heading in the right direction, even if it is still low at the moment. The data shows that returns on capital have increased substantially over the last four years to 7.1%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 162%. So we're very much inspired by what we're seeing at Tencent Music Entertainment Group thanks to its ability to profitably reinvest capital.
The Key Takeaway
All in all, it's terrific to see that Tencent Music Entertainment Group is reaping the rewards from prior investments and is growing its capital base. And since the stock has fallen 24% over the last year, there might be an opportunity here. So researching this company further and determining whether or not these trends will continue seems justified.
If you want to continue researching Tencent Music Entertainment Group, you might be interested to know about the 1 warning sign that our analysis has discovered.
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.
This article by Simply Wall St is general in nature. 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.
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