To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at China Communications Services (HKG:552) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for China Communications Services:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.044 = CN¥2.0b ÷ (CN¥119b - CN¥74b) (Based on the trailing twelve months to June 2023).
Therefore, China Communications Services has an ROCE of 4.4%. Ultimately, that's a low return and it under-performs the Construction industry average of 6.5%.
View our latest analysis for China Communications Services
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, you can check out the forecasts from the analysts covering China Communications Services here for free.
So How Is China Communications Services' ROCE Trending?
When we looked at the ROCE trend at China Communications Services, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 4.4% from 9.1% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. 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 62% 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
The Key Takeaway
To conclude, we've found that China Communications Services is reinvesting in the business, but returns have been falling. Since the stock has declined 35% over the last five years, investors may not be too optimistic on this trend improving either. Therefore based on the analysis done in this article, we don't think China Communications Services has the makings of a multi-bagger.
If you want to continue researching China Communications Services, you might be interested to know about the 1 warning sign that our analysis has discovered.
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.