Capital Allocation Trends At Focusrite (LON:TUNE) Aren't Ideal
To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Focusrite (LON:TUNE) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What Is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Focusrite:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.19 = UK£26m ÷ (UK£211m - UK£73m) (Based on the trailing twelve months to August 2023).
So, Focusrite has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Consumer Durables industry average of 11% it's much better.
View our latest analysis for Focusrite
Above you can see how the current ROCE for Focusrite compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is Focusrite's ROCE Trending?
When we looked at the ROCE trend at Focusrite, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 19% from 28% five years ago. However it looks like Focusrite might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
On a side note, Focusrite's current liabilities have increased over the last five years to 35% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 19%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.
The Bottom Line
Bringing it all together, while we're somewhat encouraged by Focusrite's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 19% over the last five years, which potentially indicates that investors are accounting for this going forward. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.
Focusrite could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.
While Focusrite 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.
