The Returns On Capital At Contel Technology (HKG:1912) Don't Inspire Confidence

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. In light of that, when we looked at Contel Technology (HKG:1912) and its ROCE trend, we weren't exactly thrilled.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Contel Technology, this is the formula:

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

0.08 = US$2.5m ÷ (US$68m - US$36m) (Based on the trailing twelve months to December 2020).

Thus, Contel Technology has an ROCE of 8.0%. Even though it's in line with the industry average of 8.1%, it's still a low return by itself.

See 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.

So How Is Contel Technology's ROCE Trending?

On the surface, the trend of ROCE at Contel Technology doesn't inspire confidence. Around five years ago the returns on capital were 36%, but since then they've fallen to 8.0%. 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 separate but related note, it's important to know that Contel Technology has a current liabilities to total assets ratio of 53%, which we'd consider pretty high. 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.

The Bottom Line On Contel Technology's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Contel Technology is reinvesting for growth and has higher sales as a result. But since the stock has dived 89% in the last year, there could be other drivers that are influencing the business' outlook. Therefore, we'd suggest researching the stock further to uncover more about the business.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Contel Technology (of which 1 is potentially serious!) that you should know about.

While Contel Technology isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. 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.
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