Capital Allocation Trends At China Communications Construction (HKG:1800) Aren't Ideal

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. However, after investigating China Communications Construction (HKG:1800), we don't think it's current trends fit the mold of a multi-bagger.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for China Communications Construction, this is the formula:

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

0.033 = CN¥30b ÷ (CN¥1.6t - CN¥736b) (Based on the trailing twelve months to March 2023).

Therefore, China Communications Construction has an ROCE of 3.3%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 6.0%.

Check out our latest analysis for China Communications Construction

Above you can see how the current ROCE for China Communications Construction 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 China Communications Construction here for free.

What The Trend Of ROCE Can Tell Us

Unfortunately, the trend isn't great with ROCE falling from 6.8% five years ago, while capital employed has grown 113%. That being said, China Communications Construction raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. It's unlikely that all of the funds raised have been put to work yet, so as a consequence China Communications Construction might not have received a full period of earnings contribution from it.

Another thing to note, China Communications Construction has a high ratio of current liabilities to total assets of 45%. 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.

What We Can Learn From China Communications Construction's ROCE

To conclude, we've found that China Communications Construction is reinvesting in the business, but returns have been falling. And investors appear hesitant that the trends will pick up because the stock has fallen 29% in the last five years. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

China Communications Construction does have some risks, we noticed 2 warning signs (and 1 which is a bit concerning) we think you should know about.

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.