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Beware of C-Link Squared (HKG:1463) and its returns on capital

If we want to find a potential multi-bagger, there are often underlying trends that can provide clues. A common approach is to try to find a company with Return on capital employed (ROCE) which is increasing, in line with growth quantity capital employed. This shows us that it is a compounding machine, capable of continuously reinvesting its profits back into the business and generating higher returns. Although, when we looked C-Link squared (HKG:1463), it didn’t seem to tick all those boxes.

Understanding return on capital employed (ROCE)

If you’ve never worked with ROCE before, it measures the “yield” (pre-tax profit) a company generates from the capital used in its business. To calculate this metric for C-Link Squared, here is the formula:

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

0.049 = RM4.6m ÷ (RM106m – RM11m) (Based on the last twelve months to June 2021).

Therefore, C-Link Squared has a ROCE of 4.9%. In absolute terms, this is a low yield and it is also below the IT industry average of 6.3%.

See our latest analysis for C-Link Squared

SEHK:1463 Return on capital employed January 20, 2022

Historical performance is a great starting point when researching a stock. So you can see C-Link Squared’s ROCE gauge above compared to its past returns. If you want to investigate more about C-Link Squared’s past, check out this free chart of past profits, revenue and cash flow.

What can we say about the ROCE trend of C-Link Squared?

When we looked at the ROCE trend at C-Link Squared, we didn’t gain much confidence. Over the past four years, capital returns have declined to 4.9% from 36% four years ago. Although, given that revenue and the amount of assets used in the business have increased, it could suggest that the business is investing in growth and that the additional capital has resulted in a short-term reduction in ROCE. If these investments prove successful, it can bode very well for long-term stock performance.

On a related note, C-Link Squared reduced its current liabilities to 10% of total assets. This could partly explain why ROCE fell. Additionally, it may reduce some aspects of risk to the business, as the business’s suppliers or short-term creditors now fund less of its operations. Since the company is essentially funding more of its operations with its own money, one could argue that this has made the company less efficient at generating a return on investment.

What we can learn from C-Link Squared’s ROCE

While yields have fallen for C-Link Squared lately, we are encouraged to see that sales are increasing and the company is reinvesting in its operations. And long-term investors should be optimistic going forward, as the stock has returned a whopping 113% to shareholders over the past year. So while the underlying trends can already be explained by investors, we still think this stock deserves further investigation.

One last note, you should inquire about the 3 warning signs we spotted some with C-Link Squared (including 1 that makes us a little uncomfortable) .

If you want to look for strong companies with excellent earnings, check out this free list of companies with strong balance sheets and impressive returns on equity.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.