Here's What's Concerning About Cognition Holdings' (JSE:CGN) Returns On Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at Cognition Holdings (JSE:CGN) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Cognition Holdings:

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

0.061 = R16m ÷ (R309m - R51m) (Based on the trailing twelve months to December 2020).

Thus, Cognition Holdings has an ROCE of 6.1%. Ultimately, that's a low return and it under-performs the Telecom industry average of 11%.

See our latest analysis for Cognition Holdings

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Cognition Holdings, check out these free graphs here.

How Are Returns Trending?

When we looked at the ROCE trend at Cognition Holdings, we didn't gain much confidence. Around five years ago the returns on capital were 17%, but since then they've fallen to 6.1%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

What We Can Learn From Cognition Holdings' ROCE

We're a bit apprehensive about Cognition Holdings because despite more capital being deployed in the business, returns on that capital and sales have both fallen. It should come as no surprise then that the stock has fallen 23% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One more thing: We've identified 2 warning signs with Cognition Holdings (at least 1 which is a bit unpleasant) , and understanding these would certainly be useful.

While Cognition Holdings 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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