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

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. 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)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Cochlear is:

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

0.18 = AU$378m ÷ (AU$2.4b - AU$378m) (Based on the trailing twelve months to December 2021).

Therefore, Cochlear has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 12% generated by the Medical Equipment industry.

Check out 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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Cochlear doesn't inspire confidence. Around five years ago the returns on capital were 39%, but since then they've fallen to 18%. 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. If these investments prove successful, this can bode very well for long term stock performance.

In Conclusion...

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 75% to shareholders over the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.

While Cochlear doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.