Returns On Capital At China Railway Signal & Communication (HKG:3969) Paint A Concerning Picture

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at China Railway Signal & Communication (HKG:3969) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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 China Railway Signal & Communication, this is the formula:

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

0.093 = CN¥4.4b ÷ (CN¥105b - CN¥58b) (Based on the trailing twelve months to December 2020).

Therefore, China Railway Signal & Communication has an ROCE of 9.3%. In absolute terms, that's a low return but it's around the Electronic industry average of 8.1%.

See our latest analysis for China Railway Signal & Communication

In the above chart we have measured China Railway Signal & Communication's 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 China Railway Signal & Communication.

What Does the ROCE Trend For China Railway Signal & Communication Tell Us?

On the surface, the trend of ROCE at China Railway Signal & Communication doesn't inspire confidence. To be more specific, ROCE has fallen from 12% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, China Railway Signal & Communication's current liabilities are still rather high at 55% of total assets. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

In Conclusion...

To conclude, we've found that China Railway Signal & Communication is reinvesting in the business, but returns have been falling. Unsurprisingly then, the total return to shareholders over the last five years has been flat. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

Like most companies, China Railway Signal & Communication does come with some risks, and we've found 1 warning sign that you should be aware of.

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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