Capital Allocation Trends At Cochlear (ASX:COH) Aren't Ideal

To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Cochlear (ASX:COH) and its ROCE trend, we weren't exactly thrilled.

What is 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. Analysts use this formula to calculate it for Cochlear:

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

0.17 = AU$344m ÷ (AU$2.4b - AU$403m) (Based on the trailing twelve months to June 2021).

Thus, Cochlear has an ROCE of 17%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Medical Equipment industry average of 15%.

See our latest analysis for Cochlear

Above you can see how the current ROCE for Cochlear compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Cochlear.

What The Trend Of ROCE Can Tell Us

In terms of Cochlear's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 17% from 36% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that Cochlear is reinvesting for growth and has higher sales as a result. And the stock has followed suit returning a meaningful 90% to shareholders over the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.

If you're still interested in Cochlear it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.

While Cochlear isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.