Today we'll look at Cogent Communications Holdings, Inc. (NASDAQ:CCOI) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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:
0.10 = US$90m ÷ (US$949m - US$90m) (Based on the trailing twelve months to June 2019.)
Therefore, Cogent Communications Holdings has an ROCE of 10%.
Does Cogent Communications Holdings Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Cogent Communications Holdings's ROCE appears to be substantially greater than the 6.1% average in the Telecom industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Aside from the industry comparison, Cogent Communications Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
You can see in the image below how Cogent Communications Holdings's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Cogent Communications Holdings's Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Cogent Communications Holdings has total assets of US$949m and current liabilities of US$90m. Therefore its current liabilities are equivalent to approximately 9.5% of its total assets. With low levels of current liabilities, at least Cogent Communications Holdings's mediocre ROCE is not unduly boosted.
The Bottom Line On Cogent Communications Holdings's ROCE
Cogent Communications Holdings looks like an ok business, but on this analysis it is not at the top of our buy list. Of course, you might also be able to find a better stock than Cogent Communications Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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If you spot an error that warrants correction, please contact the editor at email@example.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. Thank you for reading.