Focusrite (LON:TUNE) Knows How To Allocate Capital

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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Ergo, when we looked at the ROCE trends at Focusrite (LON:TUNE), we liked what we saw.

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)

0.27 = UK£28m ÷ (UK£133m - UK£30m) (Based on the trailing twelve months to February 2022).

Therefore, Focusrite has an ROCE of 27%. 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

It's hard not to be impressed by Focusrite's returns on capital. The company has employed 254% more capital in the last five years, and the returns on that capital have remained stable at 27%. Now considering ROCE is an attractive 27%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns. You'll see this when looking at well operated businesses or favorable business models.

What We Can Learn From Focusrite's ROCE

In the end, the company has proven it can reinvest it's capital at high rates of returns, which you'll remember is a trait of a multi-bagger. On top of that, the stock has rewarded shareholders with a remarkable 237% return to those who've held over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

Focusrite does have some risks though, and we've spotted 1 warning sign for Focusrite that you might be interested in.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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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.