What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. 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.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Cogstate is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.074 = US$2.1m ÷ (US$47m - US$19m) (Based on the trailing twelve months to December 2020).
Therefore, Cogstate has an ROCE of 7.4%. On its own, that's a low figure but it's around the 8.2% average generated by the Healthcare Services industry.
Check out our latest analysis for Cogstate
Historical performance is a great place to start when researching a stock so above you can see the gauge for Cogstate's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Cogstate, check out these free graphs here.
What The Trend Of ROCE Can Tell Us
While in absolute terms it isn't a high ROCE, it's promising to see that it has been moving in the right direction. Over the last five years, returns on capital employed have risen substantially to 7.4%. Basically the business is earning more per dollar of capital invested and in addition to that, 180% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 40% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.
The Bottom Line
All in all, it's terrific to see that Cogstate is reaping the rewards from prior investments and is growing its capital base. And with a respectable 51% awarded to those who held the stock over the last five years, you could argue that these developments are starting to get the attention they deserve. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
On a separate note, we've found 1 warning sign for Cogstate you'll probably want to know about.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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. 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.
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About ASX:CGS
Cogstate
A neuroscience technology company, engages in the creation, validation, and commercialization of digital brain health assessments used in both academic and industry sponsored research.
Flawless balance sheet and undervalued.
