Today we'll look at China Telecom Corporation Limited (HKG:728) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
So, How Do We Calculate ROCE?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for China Telecom:
0.069 = CN¥30b ÷ (CN¥711b - CN¥275b) (Based on the trailing twelve months to September 2019.)
Therefore, China Telecom has an ROCE of 6.9%.
Is China Telecom's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that China Telecom's ROCE is fairly close to the Telecom industry average of 6.7%. Separate from how China Telecom stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
You can click on the image below to see (in greater detail) how China Telecom's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for China Telecom.
How China Telecom's Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.
China Telecom has total liabilities of CN¥275b and total assets of CN¥711b. Therefore its current liabilities are equivalent to approximately 39% of its total assets. China Telecom has a medium level of current liabilities, which would boost its ROCE somewhat.
What We Can Learn From China Telecom's ROCE
With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. Of course, you might also be able to find a better stock than China Telecom. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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