Capital Allocation Trends At Transtech Optelecom Science Holdings (HKG:9963) Aren't Ideal

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. 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 Transtech Optelecom Science Holdings (HKG:9963) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. Analysts use this formula to calculate it for Transtech Optelecom Science Holdings:

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

0.0085 = HK$5.9m ÷ (HK$780m - HK$81m) (Based on the trailing twelve months to June 2021).

Therefore, Transtech Optelecom Science Holdings has an ROCE of 0.8%. Ultimately, that's a low return and it under-performs the Communications industry average of 7.1%.

View our latest analysis for Transtech Optelecom Science Holdings

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Transtech Optelecom Science Holdings, check out these free graphs here.

So How Is Transtech Optelecom Science Holdings' ROCE Trending?

When we looked at the ROCE trend at Transtech Optelecom Science Holdings, we didn't gain much confidence. Around five years ago the returns on capital were 15%, but since then they've fallen to 0.8%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Transtech Optelecom Science Holdings has decreased its current liabilities to 10% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Key Takeaway

We're a bit apprehensive about Transtech Optelecom Science Holdings because despite more capital being deployed in the business, returns on that capital and sales have both fallen. It should come as no surprise then that the stock has fallen 10% over the last three years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a final note, we found 2 warning signs for Transtech Optelecom Science Holdings (1 makes us a bit uncomfortable) 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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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.