To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Cognex (NASDAQ:CGNX) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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. To calculate this metric for Cognex, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.085 = US$164m ÷ (US$2.1b - US$139m) (Based on the trailing twelve months to September 2020).
So, Cognex has an ROCE of 8.5%. In absolute terms, that's a low return but it's around the Electronic industry average of 10%.
In the above chart we have measured Cognex'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 Cognex.
The Trend Of ROCE
When we looked at the ROCE trend at Cognex, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 8.5% from 16% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.
What We Can Learn From Cognex's ROCE
Bringing it all together, while we're somewhat encouraged by Cognex's reinvestment in its own business, we're aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 313% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
Like most companies, Cognex does come with some risks, and we've found 2 warning signs that you should be aware of.
While Cognex 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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What are the risks and opportunities for Cognex?
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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