Forterra (LON:FORT) Could Be Struggling To Allocate Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. Having said that, while the ROCE is currently high for Forterra (LON:FORT), we aren't jumping out of our chairs because returns are decreasing.

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. To calculate this metric for Forterra, this is the formula:

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

0.20 = UK£53m ÷ (UK£350m - UK£91m) (Based on the trailing twelve months to December 2021).

So, Forterra has an ROCE of 20%. That's a fantastic return and not only that, it outpaces the average of 9.9% earned by companies in a similar industry.

View our latest analysis for Forterra

In the above chart we have measured Forterra's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Forterra here for free.

How Are Returns Trending?

In terms of Forterra's historical ROCE movements, the trend isn't fantastic. Historically returns on capital were even higher at 28%, but they have dropped over the last five years. 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 Forterra's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Forterra is reinvesting for growth and has higher sales as a result. In light of this, the stock has only gained 20% over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

Like most companies, Forterra does come with some risks, and we've found 1 warning sign that you should be aware of.

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.

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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.