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. This shows us that it’s a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. With that in mind, we’ve noticed some promising trends at Sonos (NASDAQ:SONO) so let’s look a bit deeper.
What Is Return On Capital Employed (ROCE)?
Just to clarify if you’re unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Sonos:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.19 = US$137m ÷ (US$1.2b – US$505m) (Based on the trailing twelve months to July 2022).
Therefore, Sonos has an ROCE of 19%. That’s a relatively normal return on capital, and it’s around the 17% generated by the Consumer Durables industry.
View our latest analysis for Sonos
In the above chart we have measured Sonos’ prior ROCE against its prior performance, but the future is arguably more important. If you’d like to see what analysts are forecasting going forward, you should check out our free report for Sonos.
How Are Returns Trending?
We’re delighted to see that Sonos is reaping rewards from its investments and is now generating some pre-tax profits. About five years ago the company was generating losses but things have turned around because it’s now earning 19% on its capital. Not only that, but the company is utilizing 348% more capital than before, but that’s to be expected from a company trying to break into profitability. This can indicate that there’s plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.
In another part of our analysis, we noticed that the company’s ratio of current liabilities to total assets decreased to 41%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. Therefore we can rest assured that the growth in ROCE is a result of the business’ fundamental improvements, rather than a cooking class featuring this company’s books. Nevertheless, there are some potential risks the company is bearing with current liabilities that high, so just keep that in mind.
Our Take On Sonos’ ROCE
To the delight of most shareholders, Sonos has now broken into profitability. Since the stock has only returned 4.7% to shareholders over the last three years, the promising fundamentals may not be recognized yet by investors. So with that in mind, we think the stock deserves further research.
If you’d like to know about the risks facing Sonos, we’ve discovered 1 warning sign that you should be aware of.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.
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