Are Cogent Communications Holdings, Inc.’s (NASDAQ:CCOI) High Returns Really That Great?

Today we'll evaluate Cogent Communications Holdings, Inc. (NASDAQ:CCOI) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting 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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

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 Cogent Communications Holdings:

0.10 = US$90m ÷ (US$949m - US$90m) (Based on the trailing twelve months to June 2019.)

So, Cogent Communications Holdings has an ROCE of 10%.

View our latest analysis for Cogent Communications Holdings

Is Cogent Communications Holdings's ROCE Good?

One way to assess ROCE is to compare similar companies. Cogent Communications Holdings's ROCE appears to be substantially greater than the 6.1% average in the Telecom industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the industry comparison for now, Cogent Communications Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

You can see in the image below how Cogent Communications Holdings's ROCE compares to its industry.

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do Cogent Communications Holdings's Current Liabilities Skew 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. 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.

Cogent Communications Holdings has total assets of US$949m and current liabilities of US$90m. As a result, its current liabilities are equal to approximately 9.5% of its total assets. With low levels of current liabilities, at least Cogent Communications Holdings's mediocre ROCE is not unduly boosted.

The Bottom Line On Cogent Communications Holdings's ROCE

If performance improves, then Cogent Communications Holdings may be an OK investment, especially at the right valuation. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.