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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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)

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 Focusrite is:

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

0.25 = UK£20m ÷ (UK£105m - UK£26m) (Based on the trailing twelve months to August 2020).

Thus, Focusrite has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Consumer Durables industry average of 7.2%.

Check out 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'd like, you can check out the forecasts from the analysts covering Focusrite here for free.

So How Is Focusrite's ROCE Trending?

When we looked at the ROCE trend at Focusrite, we didn't gain much confidence. To be more specific, while the ROCE is still high, it's fallen from 36% where it was five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

The Bottom Line On Focusrite's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Focusrite is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 623% to shareholders in the last five years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

One more thing to note, we've identified 2 warning signs with Focusrite and understanding these should be part of your investment process.

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.

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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