Shareholders of Cogent would probably like to forget the past six months even happened. The stock dropped 53.9% and now trades at $9.43. This may have investors wondering how to approach the situation.
Is there a buying opportunity in Cogent, or does it present a risk to your portfolio? See what our analysts have to say in our full research report, it’s free.
Why Do We Think Cogent Will Underperform?
Even though the stock has become cheaper, we’re cautious about Cogent. Here are three reasons why CCOI doesn’t excite us, plus one stock we’d rather own.
1. Revenue Tumbling Downwards
We at StockStory place the most emphasis on long-term growth, but within business services, a stretched historical view may miss recent innovations or disruptive industry trends. Cogent’s recent performance marks a sharp pivot from its five-year trend as its revenue has shown annualized declines of 5.6% over the last two years. 
2. New Investments Fail to Bear Fruit as ROIC Declines
We like to invest in businesses with high returns, but the trend in a company’s ROIC can also be an early indicator of future business quality.
Unfortunately, Cogent’s ROIC has decreased significantly over the last few years. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
3. High Debt Levels Increase Risk
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
Cogent’s $2.38 billion of debt exceeds the $369.7 million of cash on its balance sheet. Furthermore, its 10× net-debt-to-EBITDA ratio (based on its EBITDA of $191.8 million over the last 12 months) shows the company is overleveraged.
At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. Cogent could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.
We hope Cogent can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.
Final Judgment
Cogent doesn’t pass our quality test. After the recent drawdown, the stock trades at 8× forward EV-to-EBITDA (or $9.43 per share). This valuation tells us a lot of optimism is priced in - we think there are better opportunities elsewhere. We’d suggest looking at a fast-growing restaurant franchise with an A+ ranch dressing sauce.
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