What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. That’s why when we briefly looked at NetEase’s (NASDAQ:NTES) ROCE trend, we were pretty happy with 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 NetEase, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.18 = CN¥22b ÷ (CN¥168b – CN¥42b) (Based on the trailing twelve months to June 2023).
Thus, NetEase has an ROCE of 18%. On its own, that’s a standard return, however it’s much better than the 11% generated by the Entertainment industry.
Check out our latest analysis for NetEase
In the above chart we have measured NetEase’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 NetEase.
What The Trend Of ROCE Can Tell Us
The trend of ROCE doesn’t stand out much, but returns on a whole are decent. The company has consistently earned 18% for the last five years, and the capital employed within the business has risen 174% in that time. 18% is a pretty standard return, and it provides some comfort knowing that NetEase has consistently earned this amount. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
On a side note, NetEase has done well to reduce current liabilities to 25% of total assets over the last five years. Effectively suppliers now fund less of the business, which can lower some elements of risk.
The Bottom Line On NetEase’s ROCE
The main thing to remember is that NetEase has proven its ability to continually reinvest at respectable rates of return. On top of that, the stock has rewarded shareholders with a remarkable 175% return to those who’ve held over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
While NetEase doesn’t shine too bright in this respect, it’s still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.
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.
Valuation is complex, but we’re helping make it simple.
Find out whether NetEase is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.
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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.
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