Capital Allocation Trends At China Communications Services (HKG:552) Aren't Ideal

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at China Communications Services (HKG:552) 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?

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. Analysts use this formula to calculate it for China Communications Services:

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

0.07 = CN¥2.8b ÷ (CN¥94b - CN¥55b) (Based on the trailing twelve months to December 2020).

Therefore, China Communications Services has an ROCE of 7.0%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 9.1%.

See our latest analysis for China Communications Services

In the above chart we have measured China Communications Services' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for China Communications Services.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at China Communications Services doesn't inspire confidence. Around five years ago the returns on capital were 9.9%, but since then they've fallen to 7.0%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, China Communications Services' current liabilities are still rather high at 58% 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.

The Bottom Line On China Communications Services' ROCE

To conclude, we've found that China Communications Services is reinvesting in the business, but returns have been falling. And investors may be recognizing these trends since the stock has only returned a total of 14% to shareholders over the last five years. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

China Communications Services does have some risks though, and we've spotted 1 warning sign for China Communications Services that you might be interested in.

While China Communications Services 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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