Should We Be Excited About The Trends Of Returns At China Communications Services (HKG:552)?

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. However, after investigating China Communications Services (HKG:552), we don't think it's current trends fit the mold of a multi-bagger.

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. The formula for this calculation on China Communications Services is:

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

0.07 = CN¥2.6b ÷ (CN¥88b - CN¥51b) (Based on the trailing twelve months to June 2020).

Thus, 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 10%.

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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For China Communications Services Tell Us?

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 7.0% from 10.0% five years ago. However it looks like China Communications Services might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

Another thing to note, China Communications Services has a high ratio of current liabilities to total assets of 58%. 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.

What We Can Learn From China Communications Services' ROCE

Bringing it all together, while we're somewhat encouraged by China Communications Services' reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 72% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

China Communications Services does have some risks though, and we've spotted 2 warning signs for China Communications Services that you might be interested in.

While China Communications Services isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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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