Prime Focus (NSE:PFOCUS) Shareholders Will Want The ROCE Trajectory To Continue

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So on that note, Prime Focus (NSE:PFOCUS) looks quite promising in regards to its trends of return on capital.

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. The formula for this calculation on Prime Focus is:

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

0.079 = ₹2.0b ÷ (₹50b - ₹25b) (Based on the trailing twelve months to December 2020).

So, Prime Focus has an ROCE of 7.9%. Even though it's in line with the industry average of 7.9%, it's still a low return by itself.

Check out our latest analysis for Prime Focus

Historical performance is a great place to start when researching a stock so above you can see the gauge for Prime Focus' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Prime Focus, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

While in absolute terms it isn't a high ROCE, it's promising to see that it has been moving in the right direction. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 7.9%. The amount of capital employed has increased too, by 25%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 50% of its operations, which isn't ideal. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

What We Can Learn From Prime Focus' ROCE

A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Prime Focus has. Since the stock has only returned 25% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.

One more thing: We've identified 3 warning signs with Prime Focus (at least 1 which is concerning) , and understanding them would certainly be useful.

While Prime Focus 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. 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.
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