If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. With that in mind, we've noticed some promising trends at Fabrinet (NYSE:FN) so let's look a bit deeper.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Fabrinet:

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

0.16 = US$267m ÷ (US$2.2b - US$544m) (Based on the trailing twelve months to March 2024).

Thus, Fabrinet has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 11% generated by the Electronic industry.

In the above chart we have measured Fabrinet's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Fabrinet .

How Are Returns Trending?

We like the trends that we're seeing from Fabrinet. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 16%. Basically the business is earning more per dollar of capital invested and in addition to that, 87% more capital is being employed now too. So we're very much inspired by what we're seeing at Fabrinet thanks to its ability to profitably reinvest capital.

The Bottom Line

In summary, it's great to see that Fabrinet can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And a remarkable 387% total return over the last five years tells us that investors are expecting more good things to come in the future. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

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

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com