The return on capital at China Railway Signal & Communication (HKG:3969) does not inspire confidence | So Good News

To find a stock with multiple bags, what are the underlying trends we should look for in a company? Ideally, a business will show two trends; first a growing one return on capital employed (ROCE) and secondly an increasing amount of employed capital. Simply put, these types of businesses are compounding machines, meaning they continually reinvest their earnings at ever-higher rates of return. In light of that, when we watched China Railway Signal and 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 annual profit before tax (its rate of return), relative to the capital employed in the business. Analysts use this formula to calculate it for China Railway Signal & Communication:

Return on capital employed = Earnings before interest and tax (EBIT) ÷ (Total assets – current liabilities)

0.076 = CN¥3.9b ÷ (CN¥114b – CN¥63b) (Based on the trailing twelve months to September 2022).

Therefore, China Railway Signal & Communication has a ROCE of 7.6%. In absolute terms, that’s a low return, but it’s around the electronics industry average of 7.2%.

check out opportunities and risks within the HK Electronics industry.

In the chart above, we have measured China Railway Signal & Communications’ past ROCE against past performance, but the future is arguably more important. If you’re interested, you can see analysts’ predictions this spring free report on analyst forecasts for the company.

How is the yield trending?

Regarding China Railway Signal & Communications historical ROCE movements, the trend is not amazing. About five years ago the return on capital was 15%, but since then it has fallen to 7.6%. However, China Railway Signal & Communication appears to be able to reinvest for long-term growth, because although capital employed has increased, the company’s sales have not changed much over the past 12 months. It may take some time before the company starts to see changes in earnings from these investments.

On a side note, China Railway Signal & Communications’ current debt is still quite high at 55% of total assets. This may entail some risk because the company initially operates with a fairly large dependence on its suppliers or other types of short-term creditors. Ideally, we would like to see this reduced as it would mean fewer liabilities carrying risk.

Our view on China Railway Signal & Communications ROCE

Putting it all together, while we are somewhat encouraged by China Railway Signal & Communications’ reinvestment in its own business, we are aware of shrinking returns. And investors seem hesitant that the trends will pick up because the stock has fallen 44% over the past five years. All in all, the inherent trends aren’t typical of multibaggers, so if that’s what you’re after, we think you might have better luck elsewhere.

If you want to continue researching China Railway Signal & Communication, you may be interested to know about 1 warning sign as our analysis has discovered.

While China Railway Signal & Communication doesn’t earn the highest returns, check this out free list of companies earning high return on equity with solid balance sheets.

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This article by Simply Wall St is general. We provide commentary based on historical data and analyst forecasts only using an objective methodology, and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares, and does not take into account your goals or your financial situation. We aim to provide you with long-term focused analysis driven by fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any of the stocks mentioned.