Here's What To Make Of China Communications Construction's (HKG:1800) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at China Communications Construction (HKG:1800) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What is it?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on China Communications Construction is:

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

0.047 = CN¥32b ÷ (CN¥1.3t - CN¥588b) (Based on the trailing twelve months to September 2020).

Thus, China Communications Construction has an ROCE of 4.7%. Ultimately, that's a low return and it under-performs the Construction industry average of 10%.

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, you can check out the forecasts from the analysts covering China Communications Construction here for free.

What The Trend Of ROCE Can Tell Us

In terms of China Communications Construction's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 4.7% from 6.4% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

Another thing to note, China Communications Construction 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Key Takeaway

In summary, China Communications Construction is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors appear hesitant that the trends will pick up because the stock has fallen 32% in the last five years. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

One final note, you should learn about the 2 warning signs we've spotted with China Communications Construction (including 1 which doesn't sit too well with us) .

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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