If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Cognex (NASDAQ:CGNX), we don't think it's current trends fit the mold of a multi-bagger.
Return On Capital Employed (ROCE): What Is It?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Cognex:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.066 = US$123m ÷ (US$2.0b - US$152m) (Based on the trailing twelve months to December 2023).
Therefore, Cognex has an ROCE of 6.6%. Ultimately, that's a low return and it under-performs the Electronic industry average of 11%.
In the above chart we have measured Cognex's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Cognex for free.
What The Trend Of ROCE Can Tell Us
In terms of Cognex's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 6.6% from 18% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
The Key Takeaway
From the above analysis, we find it rather worrisome that returns on capital and sales for Cognex have fallen, meanwhile the business is employing more capital than it was five years ago. Investors haven't taken kindly to these developments, since the stock has declined 22% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
If you'd like to know about the risks facing Cognex, we've discovered 1 warning sign that you should be aware of.
While Cognex may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.