If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. However, after investigating Cochlear (ASX:COH), we don't think it's current trends fit the mold of a multi-bagger.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company 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$344m ÷ (AU$2.4b - AU$403m) (Based on the trailing twelve months to June 2021).
Therefore, Cochlear has an ROCE of 17%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Medical Equipment industry average of 15%.
Check out our latest analysis for Cochlear
Above you can see how the current ROCE for Cochlear 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 Cochlear.
So How Is Cochlear's ROCE Trending?
When we looked at the ROCE trend at Cochlear, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 17% from 36% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Cochlear. Furthermore the stock has climbed 71% over the last five years, it would appear that investors are upbeat about the future. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
If you're still interested in Cochlear it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.
While Cochlear 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.