Investors Could Be Concerned With China Communications Construction's (HKG:1800) Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. 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).

Thus, 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 6.7%.

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

Unfortunately, the trend isn't great with ROCE falling from 6.8% five years ago, while capital employed has grown 113%. Usually this isn't ideal, but given China Communications Construction conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. China Communications Construction probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

On a separate but related note, it's important to know that China Communications Construction has a current liabilities to total assets ratio of 45%, which we'd consider pretty high. 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 Key Takeaway

Bringing it all together, while we're somewhat encouraged by China Communications Construction's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 21% over the last five years, investors may not be too optimistic on this trend improving either. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

On a final note, we found 2 warning signs for China Communications Construction (1 is a bit unpleasant) you should be aware of.

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.