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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. Analysts use this formula to calculate it for Putian Communication Group:

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

0.078 = CN¥55m ÷ (CN¥1.2b - CN¥516m) (Based on the trailing twelve months to June 2023).

Thus, Putian Communication Group has an ROCE of 7.8%. In absolute terms, that's a low return, but it's much better than the Communications industry average of 5.1%.

Check out 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 Putian Communication Group's past earnings, revenue and cash flow.

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

On the surface, the trend of ROCE at Putian Communication Group doesn't inspire confidence. Around five years ago the returns on capital were 28%, but since then they've fallen to 7.8%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Putian Communication Group's current liabilities have increased over the last five years to 43% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

In Conclusion...

While returns have fallen for Putian Communication Group in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. Despite these promising trends, the stock has collapsed 98% over the last five years, so there could be other factors hurting the company's prospects. Regardless, reinvestment can pay off in the long run, so we think astute investors may want to look further into this stock.

One more thing to note, we've identified 2 warning signs with Putian Communication Group and understanding these should be part of your investment process.

While Putian Communication Group 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.