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Here’s why China Communications Services Corporation Limited’s (HKG:552) Returns On Capital Matters So Much

Simply Wall St

Today we'll evaluate China Communications Services Corporation Limited (HKG:552) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.

How Do You Calculate Return On Capital Employed?

The formula for calculating the return on capital employed is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for China Communications Services:

0.075 = CN¥2.7b ÷ (CN¥86b - CN¥50b) (Based on the trailing twelve months to June 2019.)

Therefore, China Communications Services has an ROCE of 7.5%.

Check out our latest analysis for China Communications Services

Is China Communications Services's ROCE Good?

One way to assess ROCE is to compare similar companies. In this analysis, China Communications Services's ROCE appears meaningfully below the 12% average reported by the Construction industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, China Communications Services's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.

We can see that , China Communications Services currently has an ROCE of 7.5%, less than the 10.0% it reported 3 years ago. So investors might consider if it has had issues recently. The image below shows how China Communications Services's ROCE compares to its industry, and you can click it to see more detail on its past growth.

SEHK:552 Past Revenue and Net Income, September 11th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the 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 Communications Services.

What Are Current Liabilities, And How Do They Affect China Communications Services's ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.

China Communications Services has total liabilities of CN¥50b and total assets of CN¥86b. Therefore its current liabilities are equivalent to approximately 58% of its total assets. China Communications Services has a fairly high level of current liabilities, meaningfully impacting its ROCE.

Our Take On China Communications Services's ROCE

Even so, the company reports a mediocre ROCE, and there may be better investments out there. Of course, you might also be able to find a better stock than China Communications Services. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like China Communications Services better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Thank you for reading.