Returns On Capital Signal Tricky Times Ahead For Fertilizantes Heringer (BVMF:FHER3)

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. Having said that, while the ROCE is currently high for Fertilizantes Heringer (BVMF:FHER3), we aren't jumping out of our chairs because returns are decreasing.

What is 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 Fertilizantes Heringer:

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

0.25 = R$311m ÷ (R$1.9b - R$682m) (Based on the trailing twelve months to June 2021).

Thus, Fertilizantes Heringer has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Chemicals industry average of 13%.

Check out our latest analysis for Fertilizantes Heringer

Historical performance is a great place to start when researching a stock so above you can see the gauge for Fertilizantes Heringer's ROCE against it's prior returns. If you'd like to look at how Fertilizantes Heringer has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Fertilizantes Heringer's ROCE Trending?

When we looked at the ROCE trend at Fertilizantes Heringer, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 45%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Fertilizantes Heringer has done well to pay down its current liabilities to 35% of total assets. Considering it used to be 89%, that's a huge drop in that ratio and it would explain the decline in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On Fertilizantes Heringer's ROCE

While returns have fallen for Fertilizantes Heringer in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has done incredibly well with a 640% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

Fertilizantes Heringer does come with some risks though, we found 5 warning signs in our investment analysis, and 3 of those make us uncomfortable...

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning 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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