Today we’ll look at China Telecom Corporation Limited (HKG:728) and reflect on its potential as an investment. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
So, How Do We Calculate ROCE?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for China Telecom:
0.071 = CN¥29b ÷ (CN¥663b – CN¥259b) (Based on the trailing twelve months to December 2018.)
So, China Telecom has an ROCE of 7.1%.
Does China Telecom Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see China Telecom’s ROCE is around the 8.7% average reported by the Telecom industry. Separate from how China Telecom stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for China Telecom.
China Telecom’s Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
China Telecom has total assets of CN¥663b and current liabilities of CN¥259b. Therefore its current liabilities are equivalent to approximately 39% of its total assets. China Telecom has a medium level of current liabilities, which would boost its ROCE somewhat.
What We Can Learn From China Telecom’s ROCE
Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects out there. Of course you might be able to find a better stock than China Telecom. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like China Telecom better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.