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Are Cogent Communications Holdings, Inc.’s (NASDAQ:CCOI) High Returns Really That Great?

Simply Wall St

Today we'll evaluate Cogent Communications Holdings, Inc. (NASDAQ:CCOI) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.

So, How Do We Calculate ROCE?

Analysts use this formula to calculate return on capital employed:

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

Or for Cogent Communications Holdings:

0.12 = US$99m ÷ (US$932m - US$90m) (Based on the trailing twelve months to December 2019.)

Therefore, Cogent Communications Holdings has an ROCE of 12%.

Check out our latest analysis for Cogent Communications Holdings

Does Cogent Communications Holdings Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Cogent Communications Holdings's ROCE appears to be substantially greater than the 5.9% average in the Telecom industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Cogent Communications Holdings sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

In our analysis, Cogent Communications Holdings's ROCE appears to be 12%, compared to 3 years ago, when its ROCE was 9.0%. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Cogent Communications Holdings's past growth compares to other companies.

NasdaqGS:CCOI Past Revenue and Net Income May 7th 2020

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Cogent Communications Holdings.

How Cogent Communications Holdings's Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Cogent Communications Holdings has current liabilities of US$90m and total assets of US$932m. As a result, its current liabilities are equal to approximately 9.6% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), Cogent Communications Holdings earns a sound return on capital employed.

What We Can Learn From Cogent Communications Holdings's ROCE

This is good to see, and while better prospects may exist, Cogent Communications Holdings seems worth researching further. Cogent Communications Holdings shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

I will like Cogent Communications Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.