What trends should we look for it we want to identify stocks that can multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at Warner Music Group (NASDAQ:WMG) and its trend of ROCE, we really liked what we saw.

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. The formula for this calculation on Warner Music Group is:

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

0.19 = US$1.0b ÷ (US$8.8b - US$3.6b) (Based on the trailing twelve months to June 2024).

Therefore, Warner Music Group has an ROCE of 19%. On its own, that's a standard return, however it's much better than the 12% generated by the Entertainment industry.

Above you can see how the current ROCE for Warner Music Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Warner Music Group .

How Are Returns Trending?

We like the trends that we're seeing from Warner Music Group. Over the last five years, returns on capital employed have risen substantially to 19%. 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 54%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

On a separate but related note, it's important to know that Warner Music Group has a current liabilities to total assets ratio of 40%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On Warner Music Group's ROCE

In summary, it's great to see that Warner Music Group can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Astute investors may have an opportunity here because the stock has declined 28% in the last three years. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

If you want to know some of the risks facing Warner Music Group we've found 3 warning signs (1 is a bit unpleasant!) that you should be aware of before investing here.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.