Ruicheng (China) Media Group (HKG:1640) Could Be Struggling To Allocate Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Ruicheng (China) Media Group (HKG:1640) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding 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. The formula for this calculation on Ruicheng (China) Media Group is:

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

0.01 = CN¥2.8m ÷ (CN¥407m - CN¥140m) (Based on the trailing twelve months to December 2020).

Therefore, Ruicheng (China) Media Group has an ROCE of 1.0%. In absolute terms, that's a low return and it also under-performs the Media industry average of 5.1%.

See our latest analysis for Ruicheng (China) Media Group

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Ruicheng (China) Media Group's past further, check out this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

On the surface, the trend of ROCE at Ruicheng (China) Media Group doesn't inspire confidence. Around four years ago the returns on capital were 16%, but since then they've fallen to 1.0%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

What We Can Learn From Ruicheng (China) Media Group's ROCE

We're a bit apprehensive about Ruicheng (China) Media Group because despite more capital being deployed in the business, returns on that capital and sales have both fallen. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 107%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One more thing: We've identified 6 warning signs with Ruicheng (China) Media Group (at least 3 which are significant) , and understanding these would certainly be useful.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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