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. Although, when we looked at China Telecom (HKG:728), it didn't seem to tick all of these boxes.
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)
0.068 = CN¥37b ÷ (CN¥849b - CN¥309b) (Based on the trailing twelve months to March 2024).
Therefore, China Telecom has an ROCE of 6.8%. On its own, that's a low figure but it's around the 6.2% average generated by the Telecom industry.
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 analyst report for China Telecom .
What Can We Tell From China Telecom's ROCE Trend?
The returns on capital haven't changed much for China Telecom in recent years. The company has employed 28% more capital in the last five years, and the returns on that capital have remained stable at 6.8%. 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
In conclusion, China Telecom has been investing more capital into the business, but returns on that capital haven't increased. Although the market must be expecting these trends to improve because the stock has gained 82% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
China Telecom does have some risks though, and we've spotted 1 warning sign for China Telecom that you might be interested in.
While China Telecom 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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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