Here’s why China Communications Construction Company Limited’s (HKG:1800) Returns On Capital Matters So Much

Today we'll evaluate China Communications Construction Company Limited (HKG:1800) 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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'.

So, How Do We Calculate ROCE?

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 Construction:

0.048 = CN¥29b ÷ (CN¥1.1t - CN¥526b) (Based on the trailing twelve months to December 2019.)

So, China Communications Construction has an ROCE of 4.8%.

Check out our latest analysis for China Communications Construction

Does China Communications Construction Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. We can see China Communications Construction's ROCE is meaningfully below the Construction industry average of 12%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how China Communications Construction 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.

We can see that, China Communications Construction currently has an ROCE of 4.8%, less than the 7.1% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how China Communications Construction's past growth compares to other companies.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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 only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for China Communications Construction.

What Are Current Liabilities, And How Do They Affect China Communications Construction'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 counteract this, we check if a company has high current liabilities, relative to its total assets.

China Communications Construction has total assets of CN¥1.1t and current liabilities of CN¥526b. As a result, its current liabilities are equal to approximately 47% of its total assets. China Communications Construction has a medium level of current liabilities, which would boost its ROCE somewhat.

The Bottom Line On China Communications Construction's ROCE

Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects out there. Of course, you might also be able to find a better stock than China Communications Construction. So you may wish to see this free collection of other companies that have grown earnings strongly.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.

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. Thank you for reading.