If we want to find a stock that could multiply over the long term, what are the underlying trends we should be looking for? Among other things, we will want to see two things; first, growth to return to on capital employed (ROCE) and on the other hand, an expansion of the quantity capital employed. Simply put, these types of businesses are slot machines, meaning they continually reinvest their profits at ever-higher rates of return. However, after investigating cochlear (ASX:COH), we don’t think current trends fit the mold of a multi-bagger.
Understanding return on capital employed (ROCE)
Just to clarify if you’re not sure, ROCE is a measure of the pre-tax income (as a percentage) that a business earns on the capital invested in its business. The formula for this calculation on Cochlear is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.17 = AU$344 million ÷ (AU$2.4 billion – AU$403 million) (Based on the last twelve months to June 2021).
Therefore, Cochlear has a ROCE of 17%. In absolute terms, this is a fairly normal return, and somewhat close to the medical equipment industry average of 15%.
Above you can see how Cochlear’s current ROCE compares to its past returns on capital, but there’s little you can say about the past. If you want to see what analysts predict for the future, you should check out our free report for Cochlear.
So, what is the Cochlear ROCE trend?
When we looked at the ROCE trend at Cochlear, we didn’t gain much confidence. Over the past five years, capital returns have declined to 17% from 36% five years ago. However, given that capital employed and revenue have both increased, it appears that the company is currently continuing to grow, following short-term returns. If these investments prove successful, it can bode very well for long-term stock performance.
Although returns to capital have fallen in the short term, we think it is promising that both revenue and capital employed have increased for Cochlear. Moreover, the stock has climbed 71% in the last five years, it would seem that investors are optimistic about the future. So while the underlying trends can already be explained by investors, we still think this stock deserves further investigation.
If you’re still interested in Cochlear, it’s worth checking out our FREE Intrinsic Value Estimate to see if it is trading at an attractive price in other respects.
Although Cochlear doesn’t get the highest yield, check out this free list of companies that achieve high returns on equity with strong balance sheets.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.