The Returns On Capital At China Communications Construction (HKG:1800) Don't Inspire Confidence

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. 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?

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)

0.048 = CN¥34b ÷ (CN¥1.3t - CN¥583b) (Based on the trailing twelve months to December 2020).

Thus, China Communications Construction has an ROCE of 4.8%. Ultimately, that's a low return and it under-performs the Construction industry average of 9.1%.

Check out our latest analysis for China Communications Construction

In the above chart we have measured China Communications Construction'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 China Communications Construction here for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at China Communications Construction doesn't inspire confidence. To be more specific, ROCE has fallen from 6.5% over the last five years. 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 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.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that China Communications Construction is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 52% 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.

One more thing: We've identified 3 warning signs with China Communications Construction (at least 1 which shouldn't be ignored) , and understanding them would certainly be useful.

While China Communications Construction may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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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