Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think China Telecom (HKG:728) 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)
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. 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).
Thus, China Telecom has an ROCE of 6.8%. Even though it's in line with the industry average of 7.0%, it's still a low return by itself.
Above you can see how the current ROCE for China Telecom compares to its prior returns on capital, but there's only so much you can tell from the past. 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 consistently earned 6.8% for the last five years, and the capital employed within the business has risen 28% in that time. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.
The Bottom Line On China Telecom's ROCE
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 49% over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
Like most companies, China Telecom does come with some risks, and we've found 1 warning sign that you should be aware of.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.