Capital Allocation Trends At Contel Technology (HKG:1912) Aren't Ideal

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Contel Technology (HKG:1912) and its ROCE trend, we weren't exactly thrilled.

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 Contel Technology is:

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

0.10 = US$3.6m ÷ (US$58m - US$22m) (Based on the trailing twelve months to June 2022).

So, Contel Technology has an ROCE of 10%. In absolute terms, that's a satisfactory return, but compared to the Electronic industry average of 6.8% it's much better.

Check out our latest analysis for Contel Technology

Historical performance is a great place to start when researching a stock so above you can see the gauge for Contel Technology's ROCE against it's prior returns. If you're interested in investigating Contel Technology'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 Contel Technology doesn't inspire confidence. Over the last five years, returns on capital have decreased to 10% from 28% five years ago. 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.

On a side note, Contel Technology has done well to pay down its current liabilities to 39% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Contel Technology's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Contel Technology have fallen, meanwhile the business is employing more capital than it was five years ago. Unsurprisingly then, the stock has dived 93% over the last three years, so investors are recognizing these changes and don't like the company's prospects. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One more thing, we've spotted 2 warning signs facing Contel Technology that you might find interesting.

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.