Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. So when we looked at iQIYI (NASDAQ:IQ) and its trend of ROCE, we really liked what we saw.

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 iQIYI is:

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

0.075 = CN¥1.8b ÷ (CN¥46b - CN¥21b) (Based on the trailing twelve months to December 2024).

So, iQIYI has an ROCE of 7.5%. Ultimately, that's a low return and it under-performs the Entertainment industry average of 9.7%.

Check out our latest analysis for iQIYI

In the above chart we have measured iQIYI'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 iQIYI for free.

The Trend Of ROCE

Shareholders will be relieved that iQIYI has broken into profitability. The company now earns 7.5% on its capital, because five years ago it was incurring losses. Interestingly, the capital employed by the business has remained relatively flat, so these higher returns are either from prior investments paying off or increased efficiencies. With no noticeable increase in capital employed, it's worth knowing what the company plans on doing going forward in regards to reinvesting and growing the business. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.

Another thing to note, iQIYI has a high ratio of current liabilities to total assets of 47%. 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.

In Conclusion...

In summary, we're delighted to see that iQIYI has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Although the company may be facing some issues elsewhere since the stock has plunged 87% in the last five years. Regardless, we think the underlying fundamentals warrant this stock for further investigation.

If you'd like to know more about iQIYI, we've spotted 2 warning signs, and 1 of them is a bit unpleasant.

While iQIYI 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.