China Tobacco International (HK) (HKG:6055) Might Be Having Difficulty Using Its Capital Effectively

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. 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, while the ROCE is currently high for China Tobacco International (HK) (HKG:6055), we aren't jumping out of our chairs because returns are decreasing.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on China Tobacco International (HK) is:

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

0.34 = HK$935m ÷ (HK$6.7b - HK$4.0b) (Based on the trailing twelve months to December 2023).

Therefore, China Tobacco International (HK) has an ROCE of 34%. That's a fantastic return and not only that, it outpaces the average of 7.5% earned by companies in a similar industry.

Check out our latest analysis for China Tobacco International (HK)

Above you can see how the current ROCE for China Tobacco International (HK) compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering China Tobacco International (HK) for free.

What Does the ROCE Trend For China Tobacco International (HK) Tell Us?

On the surface, the trend of ROCE at China Tobacco International (HK) doesn't inspire confidence. To be more specific, while the ROCE is still high, it's fallen from 54% where it was five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, China Tobacco International (HK) has decreased its current liabilities to 59% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Keep in mind 59% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that China Tobacco International (HK) is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 110% return over the last five years, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we'd be optimistic on the stock going forward.

If you want to continue researching China Tobacco International (HK), you might be interested to know about the 1 warning sign that our analysis has discovered.

China Tobacco International (HK) is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.