If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. With that in mind, we've noticed some promising trends at Cloud Music (HKG:9899) so let's look a bit deeper.

What Is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Cloud Music is:

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

0.0033 = CN¥27m ÷ (CN¥11b - CN¥2.7b) (Based on the trailing twelve months to June 2023).

Therefore, Cloud Music has an ROCE of 0.3%. Ultimately, that's a low return and it under-performs the Entertainment industry average of 6.5%.

View our latest analysis for Cloud Music

Above you can see how the current ROCE for Cloud Music 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 Cloud Music here for free.

What Does the ROCE Trend For Cloud Music Tell Us?

The fact that Cloud Music is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making four years ago but is is now generating 0.3% on its capital. And unsurprisingly, like most companies trying to break into the black, Cloud Music is utilizing 38% more capital than it was four years ago. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

What We Can Learn From Cloud Music's ROCE

To the delight of most shareholders, Cloud Music has now broken into profitability. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 16% return over the last year. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

On a final note, we've found 1 warning sign for Cloud Music that we think you should be aware of.

While Cloud Music may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.