If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. In light of that, when we looked at China Railway Signal & Communication (HKG:3969) and its ROCE trend, we weren't exactly thrilled.
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 China Railway Signal & Communication, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.084 = CN¥4.4b ÷ (CN¥117b - CN¥65b) (Based on the trailing twelve months to September 2023).
So, China Railway Signal & Communication has an ROCE of 8.4%. In absolute terms, that's a low return, but it's much better than the Electronic industry average of 6.1%.
View our latest analysis for China Railway Signal & Communication
In the above chart we have measured China Railway Signal & Communication'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 China Railway Signal & Communication.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at China Railway Signal & Communication, we didn't gain much confidence. To be more specific, ROCE has fallen from 14% over the last five years. 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 may take some time before the company starts to see any change in earnings from these investments.
On a separate but related note, it's important to know that China Railway Signal & Communication has a current liabilities to total assets ratio of 55%, which we'd consider pretty high. 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.
What We Can Learn From China Railway Signal & Communication's ROCE
Bringing it all together, while we're somewhat encouraged by China Railway Signal & Communication's reinvestment in its own business, we're aware that returns are shrinking. And in the last five years, the stock has given away 41% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think China Railway Signal & Communication has the makings of a multi-bagger.
One more thing, we've spotted 1 warning sign facing China Railway Signal & Communication that you might find interesting.
While China Railway Signal & Communication 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.