There Are Reasons To Feel Uneasy About China Communications Services' (HKG:552) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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.

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

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

0.039 = CN¥1.6b ÷ (CN¥100b - CN¥58b) (Based on the trailing twelve months to December 2021).

So, China Communications Services has an ROCE of 3.9%. Ultimately, that's a low return and it under-performs the Construction industry average of 8.5%.

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

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 3.9%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

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.

The Bottom Line

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. Unsurprisingly then, the total return to shareholders over the last five years has been flat. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

One more thing, we've spotted 1 warning sign facing China Communications Services that you might find interesting.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.