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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. And in light of that, the trends we're seeing at Cogent Communications Holdings' (NASDAQ:CCOI) look very promising so lets take a look.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Cogent Communications Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.25 = US$107m ÷ (US$853m - US$423m) (Based on the trailing twelve months to March 2021).
Therefore, Cogent Communications Holdings has an ROCE of 25%. That's a fantastic return and not only that, it outpaces the average of 12% earned by companies in a similar industry.
Above you can see how the current ROCE for Cogent Communications Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Cogent Communications Holdings.
What Does the ROCE Trend For Cogent Communications Holdings Tell Us?
Cogent Communications Holdings has not disappointed in regards to ROCE growth. We found that the returns on capital employed over the last five years have risen by 188%. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. Interestingly, the business may be becoming more efficient because it's applying 27% less capital than it was five years ago. If this trend continues, the business might be getting more efficient but it's shrinking in terms of total assets.
For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 50% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.
Our Take On Cogent Communications Holdings' ROCE
From what we've seen above, Cogent Communications Holdings has managed to increase it's returns on capital all the while reducing it's capital base. Since the stock has returned a staggering 146% to shareholders over the last five years, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if Cogent Communications Holdings can keep these trends up, it could have a bright future ahead.
If you want to know some of the risks facing Cogent Communications Holdings we've found 6 warning signs (3 shouldn't be ignored!) that you should be aware of before investing here.
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.
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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