Cochlear (ASX:COH) Could Be Struggling To Allocate Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. So while Cochlear (ASX:COH) has a high ROCE right now, lets see what we can decipher from how returns are changing.

Return On Capital Employed (ROCE): What Is It?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Cochlear, this is the formula:

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

0.20 = AU$406m ÷ (AU$2.6b - AU$578m) (Based on the trailing twelve months to June 2023).

Thus, Cochlear has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Medical Equipment industry average of 9.5%.

Check out our latest analysis for Cochlear

In the above chart we have measured Cochlear's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Cochlear.

How Are Returns Trending?

On the surface, the trend of ROCE at Cochlear doesn't inspire confidence. Historically returns on capital were even higher at 40%, but they have dropped over the last five years. 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.

Our Take On Cochlear's ROCE

While returns have fallen for Cochlear in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has followed suit returning a meaningful 42% 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.

High returns are a key ingredient to strong performance, so check out our free list ofstocks 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.