There Are Reasons To Feel Uneasy About Transtech Optelecom Science Holdings' (HKG:9963) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. 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 that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Transtech Optelecom Science Holdings, this is the formula:

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

0.016 = HK$11m ÷ (HK$770m - HK$47m) (Based on the trailing twelve months to December 2020).

So, Transtech Optelecom Science Holdings has an ROCE of 1.6%. Ultimately, that's a low return and it under-performs the Communications industry average of 7.0%.

View our latest analysis for Transtech Optelecom Science Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Transtech Optelecom Science Holdings' ROCE against it's prior returns. 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 Can We Tell From Transtech Optelecom Science Holdings' ROCE Trend?

On the surface, the trend of ROCE at Transtech Optelecom Science Holdings doesn't inspire confidence. Over the last five years, returns on capital have decreased to 1.6% from 2.5% five 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 6.1% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Key Takeaway

From the above analysis, we find it rather worrisome that returns on capital and sales for Transtech Optelecom Science Holdings have fallen, meanwhile the business is employing more capital than it was five years ago. Investors haven't taken kindly to these developments, since the stock has declined 28% from where it was three years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Transtech Optelecom Science Holdings does have some risks though, and we've spotted 1 warning sign for Transtech Optelecom Science Holdings that you might be interested in.

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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