Focusrite (LON:TUNE) Is Reinvesting At Lower Rates Of Return

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Focusrite (LON:TUNE) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. To calculate this metric for Focusrite, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.13 = UK£18m ÷ (UK£201m - UK£66m) (Based on the trailing twelve months to February 2024).

So, Focusrite has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Consumer Durables industry average of 9.3% it's much better.

Check out 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 for free.

How Are Returns Trending?

In terms of Focusrite's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 27% 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Focusrite's current liabilities have increased over the last five years to 33% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 13%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Focusrite's reinvestment in its own business, we're aware that returns are shrinking. And in the last five years, the stock has given away 56% so the market doesn't look too hopeful on these trends strengthening any time soon. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

Focusrite does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those can't be ignored...

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.