Here's What's Concerning About China Communications Services' (HKG:552) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. 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.

What is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for China Communications Services, this is the formula:

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

0.073 = CN¥3.0b ÷ (CN¥99b - CN¥58b) (Based on the trailing twelve months to June 2021).

So, China Communications Services has an ROCE of 7.3%. On its own, that's a low figure but it's around the 8.2% average generated by the Construction industry.

See our latest analysis for China Communications Services

Above you can see how the current ROCE for China Communications Services 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 Services.

How Are Returns Trending?

When we looked at the ROCE trend at China Communications Services, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 7.3% from 10.0% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

Another thing to note, China Communications Services has a high ratio of current liabilities to total assets of 59%. 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

In summary, despite lower returns in the short term, we're encouraged to see that China Communications Services is reinvesting for growth and has higher sales as a result. However, total returns to shareholders over the last five years have been flat, which could indicate these growth trends potentially aren't accounted for yet by investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Like most companies, China Communications Services does come with some risks, and we've found 1 warning sign that you should be aware of.

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.

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.

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