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

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. However, after investigating China Communications Services (HKG:552), we don't think it's current trends fit the mold of a multi-bagger.

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What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed 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)

0.048 = CN¥2.4b ÷ (CN¥137b - CN¥88b) (Based on the trailing twelve months to December 2024).

Therefore, China Communications Services has an ROCE of 4.8%. On its own, that's a low figure but it's around the 5.9% average generated by the Construction industry.

Check out 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 analyst report for China Communications Services .

What The Trend Of ROCE Can 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 4.8% from 7.4% five years ago. 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.

On a side note, China Communications Services' current liabilities are still rather high at 64% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

In summary, China Communications Services is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Unsurprisingly then, the total return to shareholders over the last five years has been flat. Therefore based on the analysis done in this article, we don't think China Communications Services has the makings of a multi-bagger.

If you'd like to know about the risks facing China Communications Services, we've discovered 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.

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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.