Yahoo Finance Keywords Studios (LON:KWS) Might Be Having Difficulty Using Its Capital Effectively
To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. Although, when we looked at Keywords Studios (LON:KWS), it didn't seem to tick all of these boxes.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Keywords Studios, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.094 = €74m ÷ (€997m - €211m) (Based on the trailing twelve months to December 2023).
Therefore, Keywords Studios has an ROCE of 9.4%. In absolute terms, that's a low return but it's around the IT industry average of 10%.
Check out our latest analysis for Keywords Studios
Above you can see how the current ROCE for Keywords Studios compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Keywords Studios for free.
What Can We Tell From Keywords Studios' ROCE Trend?
When we looked at the ROCE trend at Keywords Studios, we didn't gain much confidence. To be more specific, ROCE has fallen from 14% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
On a related note, Keywords Studios has decreased its current liabilities to 21% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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 Keywords Studios' ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Keywords Studios. These trends are starting to be recognized by investors since the stock has delivered a 30% gain to shareholders who've held over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.
If you want to know some of the risks facing Keywords Studios we've found 3 warning signs (1 is a bit unpleasant!) that you should be aware of before investing here.
While Keywords Studios 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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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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