Some Investors May Be Worried About China Railway Signal & Communication's (HKG:3969) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. 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.

Understanding Return On Capital Employed (ROCE)

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. The formula for this calculation on China Railway Signal & Communication is:

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

0.076 = CN¥3.8b ÷ (CN¥109b - CN¥58b) (Based on the trailing twelve months to March 2022).

Thus, China Railway Signal & Communication has an ROCE of 7.6%. On its own, that's a low figure but it's around the 6.3% average generated by the Electronic industry.

View 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?

In terms of China Railway Signal & Communication's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 15%, but since then they've fallen to 7.6%. 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 separate but related note, it's important to know that China Railway Signal & Communication has a current liabilities to total assets ratio of 54%, 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On China Railway Signal & Communication's ROCE

To conclude, we've found that China Railway Signal & Communication is reinvesting in the business, but returns have been falling. And in the last five years, the stock has given away 46% so the market doesn't look too hopeful on these trends strengthening any time soon. 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.

China Railway Signal & Communication does have some risks though, and we've spotted 1 warning sign for China Railway Signal & Communication that you might be interested in.

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.

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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.