What Should Investors Know About Telecom Service One Holdings Limited’s (HKG:3997) Return On Capital?

I am writing today to help inform people who are new to the stock market and looking to gauge the potential return on investment in Telecom Service One Holdings Limited (HKG:3997).

Purchasing Telecom Service One Holdings gives you an ownership stake in the company. Owing to this, it is important that the underlying business is producing a sufficient amount of income from the capital invested by stockholders. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. To understand Telecom Service One Holdings’s capital returns we will look at a useful metric called return on capital employed. This will tell us if the company is growing your capital and placing you in good stead to sell your shares at a profit.

View our latest analysis for Telecom Service One Holdings

ROCE: Explanation and Calculation

You only have a finite amount of capital to invest, so there are only so many companies that you can add to your portfolio. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. To determine Telecom Service One Holdings’s capital return we will use ROCE, which tells us how much the company makes from the capital employed in their operations (for things like machinery, wages etc). Take a look at the formula box beneath:

ROCE Calculation for 3997

Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)

Capital Employed = (Total Assets – Current Liabilities)

∴ ROCE = HK$30m ÷ (HK$111m – HK$7.5m) = 24%

3997’s 24% ROCE means that for every HK$100 you invest, the company creates HK$23.7. Comparing this to a healthy 15% benchmark shows Telecom Service One Holdings is currently able to return a strong amount to owners for the use of their capital, which is a good sign for those who believe this will continue and the company’s management will find good uses for the earnings they create.

SEHK:3997 Last Perf November 22nd 18
SEHK:3997 Last Perf November 22nd 18

Before moving forward

Telecom Service One Holdings’s relatively strong ROCE is tied to the movement in two factors that change over time: earnings and capital requirements. At the moment Telecom Service One Holdings is in a favourable position, but this can change if these factors underperform. Because of this, it is important to look beyond the final value of 3997’s ROCE and understand what is happening to the individual components. Looking three years in the past, it is evident that 3997’s ROCE has deteriorated from 50%, indicating the company’s capital returns have declined. The movement in the earnings variable over this time shows a fall from HK$30m to HK$30m whilst capital employed has increased due to an increase in total assets and decrease in current liabilities (less borrowed money) , which means the company’s ROCE has shrunk as a result of falling earnings and simultaneous increases in capital requirements.

Next Steps

Although Telecom Service One Holdings’s ROCE has decreased over the past few years, the company still remains an attractive candidate that is capable of producing solid capital returns and a potentially strong return on investment. It is important to know that ROCE does not dictate returns alone, so you need to consider other fundamentals in the business such as future prospects and valuation. If you don’t pay attention to these factors you cannot be sure if the downward path is a signal to run, or just a blip in an otherwise solid return profile. If you’re building your portfolio and want to take a deeper look, I’ve added a few links below that will help you further evaluate 3997 or other alternatives.

  1. Future Outlook: What are well-informed industry analysts predicting for 3997’s future growth? Take a look at our free research report of analyst consensus for 3997’s outlook.
  2. Valuation: What is 3997 worth today? Is the stock undervalued, even if its ROCE is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether 3997 is currently mispriced by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.