Returns On Capital Signal Tricky Times Ahead For China Railway Signal & Communication (HKG:3969)

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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 China Railway Signal & Communication (HKG:3969) and its ROCE trend, we weren't exactly thrilled.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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)

0.097 = CN¥4.5b ÷ (CN¥108b - CN¥61b) (Based on the trailing twelve months to June 2021).

Thus, China Railway Signal & Communication has an ROCE of 9.7%. On its own that's a low return, but compared to the average of 7.5% generated by the Electronic industry, it's much better.

View our latest analysis for China Railway Signal & Communication

Above you can see how the current ROCE for China Railway Signal & Communication compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

The Trend Of ROCE

On the surface, the trend of ROCE at China Railway Signal & Communication doesn't inspire confidence. To be more specific, ROCE has fallen from 14% over the last five years. 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. If these investments prove successful, this can bode very well for long term stock performance.

On a separate but related note, it's important to know that China Railway Signal & Communication has a current liabilities to total assets ratio of 56%, 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.

What We Can Learn From China Railway Signal & Communication's ROCE

While returns have fallen for China Railway Signal & Communication in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These growth trends haven't led to growth returns though, since the stock has fallen 42% over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

One more thing to note, we've identified 1 warning sign with China Railway Signal & Communication and understanding it should be part of your investment process.

While China Railway Signal & Communication isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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.

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