Here's What To Make Of Transtech Optelecom Science Holdings' (HKG:9963) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. 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?

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. 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)

0.05 = HK$35m ÷ (HK$740m - HK$51m) (Based on the trailing twelve months to June 2020).

Therefore, Transtech Optelecom Science Holdings has an ROCE of 5.0%. In absolute terms, that's a low return and it also under-performs the Communications industry average of 6.8%.

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'd like to look at how Transtech Optelecom Science Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Transtech Optelecom Science Holdings Tell Us?

When we looked at the ROCE trend at Transtech Optelecom Science Holdings, we didn't gain much confidence. Over the last four years, returns on capital have decreased to 5.0% from 15% four years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, Transtech Optelecom Science Holdings has decreased its current liabilities to 6.9% 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.

What We Can Learn From Transtech Optelecom Science Holdings' ROCE

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. Investors haven't taken kindly to these developments, since the stock has declined 46% from where it was three years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One final note, you should learn about the 5 warning signs we've spotted with Transtech Optelecom Science Holdings (including 2 which can't be ignored) .

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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