Putian Communication Group (HKG:1720) Is Reinvesting At Lower Rates Of Return

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Putian Communication Group (HKG:1720) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Return On Capital Employed (ROCE): What Is It?

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 Putian Communication Group is:

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

0.068 = CN¥45m ÷ (CN¥1.0b - CN¥363m) (Based on the trailing twelve months to June 2022).

Therefore, Putian Communication Group has an ROCE of 6.8%. In absolute terms, that's a low return but it's around the Communications industry average of 5.9%.

See our latest analysis for Putian Communication 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'd like to look at how Putian Communication Group has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Putian Communication Group Tell Us?

In terms of Putian Communication Group's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 6.8% from 23% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Putian Communication Group's current liabilities have increased over the last five years to 35% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 6.8%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

What We Can Learn From Putian Communication Group's ROCE

In summary, Putian Communication Group is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. It seems that investors have little hope of these trends getting any better and that may have partly contributed to the stock collapsing 92% in the last five years. 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.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Putian Communication Group (of which 1 makes us a bit uncomfortable!) that you should know about.

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.