Returns Are Gaining Momentum At Cogstate (ASX:CGS)

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we've noticed some promising trends at Cogstate (ASX:CGS) so let's look a bit deeper.

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)

0.12 = US$4.7m ÷ (US$55m - US$16m) (Based on the trailing twelve months to December 2022).

Thus, Cogstate has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 8.0% generated by the Healthcare Services industry.

Check out our latest analysis for Cogstate

In the above chart we have measured Cogstate's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

SWOT Analysis for Cogstate

The Trend Of ROCE

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 12% on its capital. In addition to that, Cogstate is employing 252% 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 29%, which basically reduces it's funding from the likes of short-term creditors or suppliers. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.

The Key Takeaway

To the delight of most shareholders, Cogstate has now broken into profitability. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 47% return over the last five years. In light of that, we think it's worth looking further into this stock because if Cogstate can keep these trends up, it could have a bright future ahead.

Cogstate does have some risks though, and we've spotted 2 warning signs for Cogstate that you might be interested in.

While Cogstate may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.