Why China Tower Corporation Limited’s (HKG:788) Return On Capital Employed Might Be A Concern

Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

Today we’ll evaluate China Tower Corporation Limited (HKG:788) to determine whether it could have potential as an investment idea. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.

How Do You Calculate Return On Capital Employed?

The formula for calculating the return on capital employed is:

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

Or for China Tower:

0.051 = CN¥9.0b ÷ (CN¥329b – CN¥147b) (Based on the trailing twelve months to September 2018.)

So, China Tower has an ROCE of 5.1%.

View our latest analysis for China Tower

Does China Tower Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, China Tower’s ROCE appears to be significantly below the 8.4% average in the Telecom industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Setting aside the industry comparison for now, China Tower’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

SEHK:788 Last Perf February 12th 19
SEHK:788 Last Perf February 12th 19

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. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for China Tower.

What Are Current Liabilities, And How Do They Affect China Tower’s ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

China Tower has total assets of CN¥329b and current liabilities of CN¥147b. As a result, its current liabilities are equal to approximately 45% of its total assets. China Tower has a medium level of current liabilities, which would boost its ROCE somewhat.

What We Can Learn From China Tower’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 Tower. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like China Tower better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.