To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Speaking of which, we noticed some great changes in Madison Square Garden Entertainment's (NYSE:MSGE) returns on capital, so let's have a look.

Understanding 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. To calculate this metric for Madison Square Garden Entertainment, this is the formula:

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

0.12 = US$127m ÷ (US$1.6b - US$521m) (Based on the trailing twelve months to September 2024).

Thus, Madison Square Garden Entertainment has an ROCE of 12%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Entertainment industry average of 9.9%.

In the above chart we have measured Madison Square Garden Entertainment's 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 Madison Square Garden Entertainment .

How Are Returns Trending?

Like most people, we're pleased that Madison Square Garden Entertainment is now generating some pretax earnings. Historically the company was generating losses but as we can see from the latest figures referenced above, they're now earning 12% on their capital employed. At first glance, it seems the business is getting more proficient at generating returns, because over the same period, the amount of capital employed has reduced by 76%. Madison Square Garden Entertainment could be selling under-performing assets since the ROCE is improving.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 32% of the business, which is more than it was three years ago. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

The Key Takeaway

From what we've seen above, Madison Square Garden Entertainment has managed to increase it's returns on capital all the while reducing it's capital base. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 16% return over the last year. Therefore, we think it would be worth your time to check if these trends are going to continue.

Like most companies, Madison Square Garden Entertainment does come with some risks, and we've found 3 warning signs that you should be aware of.

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.