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Investors Shouldn't Overlook The Favourable Returns On Capital At Universal Music Group (AMS:UMG)

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. Ergo, when we looked at the ROCE trends at Universal Music Group (AMS:UMG), we liked what we saw.

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. To calculate this metric for Universal Music Group, this is the formula:

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

0.21 = €1.5b ÷ (€13b - €6.0b) (Based on the trailing twelve months to June 2022).

Therefore, Universal Music Group has an ROCE of 21%. In absolute terms that's a great return and it's even better than the Entertainment industry average of 13%.

View our latest analysis for Universal Music Group

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In the above chart we have measured Universal Music Group'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 Universal Music Group here for free.

So How Is Universal Music Group's ROCE Trending?

Universal Music Group deserves to be commended in regards to it's returns. The company has consistently earned 21% for the last three years, and the capital employed within the business has risen 51% in that time. With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return. If Universal Music Group can keep this up, we'd be very optimistic about its future.

Another thing to note, Universal Music Group has a high ratio of current liabilities to total assets of 46%. 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 Universal Music Group's ROCE

Universal Music Group has demonstrated its proficiency by generating high returns on increasing amounts of capital employed, which we're thrilled about. Despite the good fundamentals, total returns from the stock have been virtually flat over the last year. That's why we think it'd be worthwhile to look further into this stock given the fundamentals are appealing.

On a separate note, we've found 3 warning signs for Universal Music Group you'll probably want to know about.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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