Is Comba Telecom Systems Holdings (HKG:2342) Shrinking?

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. So after we looked into Comba Telecom Systems Holdings (HKG:2342), the trends above didn't look too great.

Return On Capital Employed (ROCE): What is it?

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 Comba Telecom Systems Holdings is:

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

0.0059 = HK$34m ÷ (HK$11b - HK$5.2b) (Based on the trailing twelve months to June 2020).

Thus, Comba Telecom Systems Holdings has an ROCE of 0.6%. In absolute terms, that's a low return and it also under-performs the Communications industry average of 5.0%.

View our latest analysis for Comba Telecom Systems Holdings

In the above chart we have measured Comba Telecom Systems Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Comba Telecom Systems Holdings.

How Are Returns Trending?

In terms of Comba Telecom Systems Holdings' historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 8.2%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Comba Telecom Systems Holdings to turn into a multi-bagger.

On a separate but related note, it's important to know that Comba Telecom Systems Holdings has a current liabilities to total assets ratio of 47%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 126%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One more thing to note, we've identified 1 warning sign with Comba Telecom Systems Holdings and understanding it should be part of your investment process.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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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