Over the last six months, Cogent’s shares have sunk to $43.70, producing a disappointing 13.7% loss - a stark contrast to the S&P 500’s 27.9% gain. This might have investors contemplating their next move.

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Why Is Cogent Not Exciting?

Even with the cheaper entry price, we're sitting this one out for now. Here are three reasons why CCOI doesn't excite us and a stock we'd rather own.

1. Free Cash Flow Margin Dropping

If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.

As you can see below, Cogent’s margin dropped by 39.7 percentage points over the last five years. Almost any movement in the wrong direction is undesirable because it is already burning cash. If the trend continues, it could signal it’s becoming a more capital-intensive business. Cogent’s free cash flow margin for the trailing 12 months was negative 23.2%.

2. New Investments Fail to Bear Fruit as ROIC Declines

A company’s ROIC, or return on invested capital, shows how much operating profit it makes compared to the money it has raised (debt and equity).

We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Over the last few years, Cogent’s ROIC has unfortunately decreased significantly. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.

3. Short Cash Runway Exposes Shareholders to Potential Dilution

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 burned through $233 million of cash over the last year, and its $2.37 billion of debt exceeds the $306.7 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.

Unless the Cogent’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.

We remain cautious of Cogent until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.

Final Judgment

Cogent’s business quality ultimately falls short of our standards. Following the recent decline, the stock trades at 6.1× forward EV-to-EBITDA (or $43.70 per share). While this valuation is optically cheap, the potential downside is big given its shaky fundamentals. We're fairly confident there are better stocks to buy right now. We’d recommend looking at the most entrenched endpoint security platform on the market.

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