Returns On Capital Signal Tricky Times Ahead For NetEase (NASDAQ:NTES)

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at NetEase (NASDAQ:NTES) and its ROCE trend, we weren't exactly thrilled.

What is Return On Capital Employed (ROCE)?

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. The formula for this calculation on NetEase is:

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

0.15 = CN¥15b ÷ (CN¥142b - CN¥47b) (Based on the trailing twelve months to December 2020).

Thus, NetEase has an ROCE of 15%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Entertainment industry average of 14%.

Check out our latest analysis for NetEase

roce

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.

So How Is NetEase's ROCE Trending?

We weren't thrilled with the trend because NetEase's ROCE has reduced by 38% over the last five years, while the business employed 222% more capital. Usually this isn't ideal, but given NetEase conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. NetEase probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt. Additionally, we found that NetEase's most recent EBIT figure is around the same as the prior year, so we'd attribute the drop in ROCE mostly to the capital raise.

The Bottom Line On NetEase's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that NetEase is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 336% return over the last five years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

If you'd like to know about the risks facing NetEase, we've discovered 1 warning sign that you should be aware of.

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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