Cogstate (ASX:CGS) Is Very Good At Capital Allocation

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. And in light of that, the trends we're seeing at Cogstate's (ASX:CGS) look very promising so lets take a look.

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What Is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Cogstate:

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

0.20 = US$9.7m ÷ (US$61m - US$13m) (Based on the trailing twelve months to December 2024).

So, Cogstate has an ROCE of 20%. That's a fantastic return and not only that, it outpaces the average of 9.6% earned by companies in a similar industry.

See our latest analysis for Cogstate

Above you can see how the current ROCE for Cogstate compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Cogstate .

How Are Returns Trending?

The fact that Cogstate is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 20% on its capital. In addition to that, Cogstate is employing 165% more capital than previously which is expected of a company that's trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

On a related note, the company's ratio of current liabilities to total assets has decreased to 21%, which basically reduces it's funding from the likes of short-term creditors or suppliers. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.

Our Take On Cogstate's ROCE

Long story short, we're delighted to see that Cogstate's reinvestment activities have paid off and the company is now profitable. Since the stock has returned a staggering 148% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

While Cogstate looks impressive, no company is worth an infinite price. The intrinsic value infographic for CGS helps visualize whether it is currently trading for a fair price.

Cogstate is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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