What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. However, after briefly looking over the numbers, we don't think China Communications Services (HKG:552) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Return On Capital Employed (ROCE): What Is It?
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 Communications Services is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.049 = CN¥2.3b ÷ (CN¥128b - CN¥81b) (Based on the trailing twelve months to June 2024).
Therefore, China Communications Services has an ROCE of 4.9%. In absolute terms, that's a low return but it's around the Construction industry average of 5.7%.
Above you can see how the current ROCE for China Communications Services compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for China Communications Services .
What The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at China Communications Services doesn't inspire confidence. Over the last five years, returns on capital have decreased to 4.9% from 7.5% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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.
On a side note, China Communications Services' current liabilities are still rather high at 63% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Bottom Line
In summary, China Communications Services is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors may be recognizing these trends since the stock has only returned a total of 16% to shareholders over the last five years. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.
Like most companies, China Communications Services does come with some risks, and we've found 1 warning sign that you should be aware of.
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. 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.
