Our Take On The Returns On Capital At China Unicom (Hong Kong) (HKG:762)

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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 China Unicom (Hong Kong) (HKG:762) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

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. The formula for this calculation on China Unicom (Hong Kong) is:

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

0.039 = CN¥14b ÷ (CN¥569b - CN¥212b) (Based on the trailing twelve months to September 2020).

Therefore, China Unicom (Hong Kong) has an ROCE of 3.9%. In absolute terms, that's a low return and it also under-performs the Telecom industry average of 5.7%.

See our latest analysis for China Unicom (Hong Kong)

Above you can see how the current ROCE for China Unicom (Hong Kong) 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 Unicom (Hong Kong) here for free.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at China Unicom (Hong Kong), we didn't gain much confidence. Around five years ago the returns on capital were 7.4%, but since then they've fallen to 3.9%. However it looks like China Unicom (Hong Kong) might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, China Unicom (Hong Kong) has decreased its current liabilities to 37% of total assets. So we could link some of this to the decrease in ROCE. 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

In summary, China Unicom (Hong Kong) is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors appear hesitant that the trends will pick up because the stock has fallen 34% in the last five years. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

One more thing to note, we've identified 1 warning sign with China Unicom (Hong Kong) and understanding this should be part of your investment process.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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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