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

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating China Communications Services (HKG:552), we don't think it's current trends fit the mold of a multi-bagger.

What is Return On Capital Employed (ROCE)?

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. 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)

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

Therefore, China Communications Services has an ROCE of 7.3%. In absolute terms, that's a low return but it's around the Construction industry average of 8.7%.

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

So How Is China Communications Services' ROCE Trending?

When we looked at the ROCE trend at China Communications Services, we didn't gain much confidence. To be more specific, ROCE has fallen from 10.0% 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. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, China Communications Services' current liabilities are still rather high at 59% 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. 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 Services is reinvesting for growth and has higher sales as a result. In light of this, the stock has only gained 4.9% over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

On a separate note, we've found 1 warning sign for China Communications Services you'll probably want to know about.

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. 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.