Returns On Capital Signal Tricky Times Ahead For MTR (HKG:66)

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think MTR (HKG:66) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for MTR, this is the formula:

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

0.022 = HK$6.1b ÷ (HK$291b - HK$16b) (Based on the trailing twelve months to December 2020).

Therefore, MTR has an ROCE of 2.2%. In absolute terms, that's a low return and it also under-performs the Transportation industry average of 6.3%.

See our latest analysis for MTR

In the above chart we have measured MTR's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for MTR.

What Can We Tell From MTR's ROCE Trend?

When we looked at the ROCE trend at MTR, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 2.2% from 5.9% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

The Bottom Line

In summary, we're somewhat concerned by MTR's diminishing returns on increasing amounts of capital. Despite the concerning underlying trends, the stock has actually gained 25% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

One more thing, we've spotted 1 warning sign facing MTR that you might find interesting.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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