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. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. Having said that, from a first glance at Forterra (LON:FORT) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What is 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 Forterra is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.018 = UK£5.4m ÷ (UK£373m - UK£70m) (Based on the trailing twelve months to June 2020).
Thus, Forterra has an ROCE of 1.8%. In absolute terms, that's a low return and it also under-performs the Basic Materials industry average of 8.3%.
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 to see what analysts are forecasting going forward, you should check out our free report for Forterra.
What The Trend Of ROCE Can Tell Us
In terms of Forterra's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 18% over the last four years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
What We Can Learn From Forterra's ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for Forterra have fallen, meanwhile the business is employing more capital than it was four years ago. It should come as no surprise then that the stock has fallen 32% over the last three years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
Forterra does have some risks, we noticed 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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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