Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at China Telecom (HKG:728) and its ROCE trend, we weren't exactly thrilled.
Understanding Return On Capital Employed (ROCE)
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. 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 June 2020).
So, China Telecom has an ROCE of 6.3%. Even though it's in line with the industry average of 5.8%, it's still a low return by itself.
See our latest analysis for China Telecom
In the above chart we have measured China Telecom's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is China Telecom's ROCE Trending?
There are better returns on capital out there than what we're seeing at China Telecom. Over the past five years, ROCE has remained relatively flat at around 6.3% and the business has deployed 23% more capital into its operations. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
The Bottom Line
As we've seen above, China Telecom's returns on capital haven't increased but it is reinvesting in the business. And investors appear hesitant that the trends will pick up because the stock has fallen 33% in the last five years. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.
If you want to continue researching China Telecom, you might be interested to know about the 1 warning sign that our analysis has discovered.
While China Telecom isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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