Here's What Contel Technology's (HKG:1912) Strong Returns On Capital Means

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. Ergo, when we looked at the ROCE trends at Contel Technology (HKG:1912), we liked what we saw.

What is 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)

0.24 = US$7.6m ÷ (US$64m - US$32m) (Based on the trailing twelve months to June 2020).

So, Contel Technology has an ROCE of 24%. That's a fantastic return and not only that, it outpaces the average of 7.7% earned by companies in a similar industry.

View 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 want to delve into the historical earnings, revenue and cash flow of Contel Technology, check out these free graphs here.

What Can We Tell From Contel Technology's ROCE Trend?

It's hard not to be impressed by Contel Technology's returns on capital. Over the past four years, ROCE has remained relatively flat at around 24% and the business has deployed 281% more capital into its operations. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.

Another thing to note, Contel Technology has a high ratio of current liabilities to total assets of 50%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From Contel Technology's ROCE

In short, we'd argue Contel Technology has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. Despite these impressive fundamentals, the stock has collapsed 89% over the last year, so there is likely other factors affecting the company's future prospects. That's why it's worth looking further into this stock because while these fundamentals look good, there could be other issues with the business.

Contel Technology does have some risks, we noticed 3 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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