Should You Be Impressed By China Telecom's (HKG:728) Returns on Capital?

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. Although, when we looked at China Telecom (HKG:728), it didn't seem to tick all of these boxes.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for China Telecom:

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

0.063 = CN¥28b ÷ (CN¥714b - CN¥270b) (Based on the trailing twelve months to September 2020).

So, China Telecom has an ROCE of 6.3%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.7%.

Check out our latest analysis for China Telecom

Above you can see how the current ROCE for China Telecom compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering China Telecom here for free.

What The Trend Of ROCE Can Tell Us

In terms of China Telecom's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 8.0%, but since then they've fallen to 6.3%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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.

In Conclusion...

In summary, China Telecom is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And in the last five years, the stock has given away 16% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think China Telecom has the makings of a multi-bagger.

If you'd like to know about the risks facing China Telecom, we've discovered 1 warning sign that you should be aware of.

While China Telecom may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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. 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.
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