When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. This indicates the company is producing less profit from its investments and its total assets are decreasing. Having said that, after a brief look, Melco Resorts & Entertainment (NASDAQ:MLCO) we aren't filled with optimism, but let's investigate further.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Melco Resorts & Entertainment is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.073 = US$501m ÷ (US$8.0b - US$1.1b) (Based on the trailing twelve months to September 2024).
Therefore, Melco Resorts & Entertainment has an ROCE of 7.3%. In absolute terms, that's a low return but it's around the Hospitality industry average of 9.1%.
In the above chart we have measured Melco Resorts & Entertainment's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Melco Resorts & Entertainment for free.
What Can We Tell From Melco Resorts & Entertainment's ROCE Trend?
There is reason to be cautious about Melco Resorts & Entertainment, given the returns are trending downwards. About five years ago, returns on capital were 11%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Melco Resorts & Entertainment to turn into a multi-bagger.
On a side note, Melco Resorts & Entertainment has done well to pay down its current liabilities to 14% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
The Key Takeaway
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Unsurprisingly then, the stock has dived 76% over the last five years, so investors are recognizing these changes and don't like the company's prospects. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
Melco Resorts & Entertainment does have some risks though, and we've spotted 1 warning sign for Melco Resorts & Entertainment that you might be interested in.
While Melco Resorts & Entertainment 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.
