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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in Cogstate's (ASX:CGS) returns on capital, so let's have 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. The formula for this calculation on Cogstate is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.055 = US$2.3m ÷ (US$54m - US$12m) (Based on the trailing twelve months to June 2023).
So, Cogstate has an ROCE of 5.5%. Ultimately, that's a low return and it under-performs the Healthcare Services industry average of 8.8%.
In the above chart we have measured Cogstate'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 Cogstate.
What Does the ROCE Trend For Cogstate Tell Us?
Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. Over the last five years, returns on capital employed have risen substantially to 5.5%. Basically the business is earning more per dollar of capital invested and in addition to that, 248% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
One more thing to note, Cogstate has decreased current liabilities to 23% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. So this improvement in ROCE has come from the business' underlying economics, which is great to see.
The Bottom Line On Cogstate's ROCE
All in all, it's terrific to see that Cogstate is reaping the rewards from prior investments and is growing its capital base. And a remarkable 137% total return over the last five years tells us that investors are expecting more good things to come in the future. Therefore, we think it would be worth your time to check if these trends are going to continue.
If you want to know some of the risks facing Cogstate we've found 2 warning signs (1 is significant!) that you should be aware of before investing here.
While Cogstate 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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.