China Communications Construction (HKG:1800) Could Be Struggling To Allocate Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at China Communications Construction (HKG:1800) and its ROCE trend, we weren't exactly thrilled.

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 China Communications Construction, this is the formula:

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

0.05 = CN¥39b ÷ (CN¥1.4t - CN¥592b) (Based on the trailing twelve months to March 2021).

So, China Communications Construction has an ROCE of 5.0%. Ultimately, that's a low return and it under-performs the Construction industry average of 7.4%.

View 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 to see what analysts are forecasting going forward, you should check out our free report for China Communications Construction.

What Can We Tell From China Communications Construction's ROCE Trend?

When we looked at the ROCE trend at China Communications Construction, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 5.0% from 6.3% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, China Communications Construction's current liabilities are still rather high at 44% of total assets. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From China Communications Construction's ROCE

While returns have fallen for China Communications Construction in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. However, despite the promising trends, the stock has fallen 47% over the last five years, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

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

While China Communications Construction 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. 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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