PCCW (HKG:8) May Have Issues Allocating Its Capital

There are a few key trends to look for if we want to identify the next multi-bagger. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at PCCW (HKG:8), it didn't seem to tick all of these boxes.

What is 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 PCCW:

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

0.051 = HK$4.1b ÷ (HK$98b - HK$18b) (Based on the trailing twelve months to December 2020).

Therefore, PCCW has an ROCE of 5.1%. In absolute terms, that's a low return and it also under-performs the Telecom industry average of 6.6%.

Check out our latest analysis for PCCW

Above you can see how the current ROCE for PCCW compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For PCCW Tell Us?

On the surface, the trend of ROCE at PCCW doesn't inspire confidence. Around five years ago the returns on capital were 10%, but since then they've fallen to 5.1%. However it looks like PCCW 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'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.

What We Can Learn From PCCW's ROCE

Bringing it all together, while we're somewhat encouraged by PCCW's reinvestment in its own business, we're aware that returns are shrinking. And investors may be recognizing these trends since the stock has only returned a total of 21% to shareholders over the last five years. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

PCCW does have some risks, we noticed 2 warning signs (and 1 which is significant) we think you should know about.

While PCCW 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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