Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. On that note, looking into NetDragon Websoft Holdings (HKG:777), we weren't too upbeat about how things were going.

Return On Capital Employed (ROCE): What Is It?

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 NetDragon Websoft Holdings, this is the formula:

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

0.12 = CN¥787m ÷ (CN¥11b - CN¥4.1b) (Based on the trailing twelve months to June 2024).

Thus, NetDragon Websoft Holdings has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Entertainment industry average of 9.7% it's much better.

In the above chart we have measured NetDragon Websoft Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for NetDragon Websoft Holdings .

What Does the ROCE Trend For NetDragon Websoft Holdings Tell Us?

In terms of NetDragon Websoft Holdings' historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 15% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on NetDragon Websoft Holdings becoming one if things continue as they have.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 38%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

The Key Takeaway

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Investors haven't taken kindly to these developments, since the stock has declined 13% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

On a final note, we've found 2 warning signs for NetDragon Websoft Holdings that we think you should be aware of.

While NetDragon Websoft Holdings 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.