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What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So while Focusrite (LON:TUNE) has a high ROCE right now, lets see what we can decipher from how returns are changing.
Understanding Return On Capital Employed (ROCE)
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 Focusrite:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.20 = UK£26m ÷ (UK£187m - UK£57m) (Based on the trailing twelve months to February 2023).
Thus, Focusrite has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Consumer Durables industry average of 12%.
See our latest analysis for Focusrite
In the above chart we have measured Focusrite'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 Focusrite here for free.
The Trend Of ROCE
On the surface, the trend of ROCE at Focusrite doesn't inspire confidence. Historically returns on capital were even higher at 29%, but they have dropped over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 31%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.
The Key Takeaway
In summary, Focusrite is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And with the stock having returned a mere 31% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.