If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think L.B. Foster (NASDAQ:FSTR) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
What is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for L.B. Foster:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.051 = US$14m ÷ (US$374m - US$108m) (Based on the trailing twelve months to March 2021).
So, L.B. Foster has an ROCE of 5.1%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 9.4%.
Above you can see how the current ROCE for L.B. Foster compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for L.B. Foster.
What Can We Tell From L.B. Foster's ROCE Trend?
Over the past five years, L.B. Foster's ROCE has remained relatively flat while the business is using 44% less capital than before. To us that doesn't look like a multi-bagger because the company appears to be selling assets and it's returns aren't increasing. Not only that, but the low returns on this capital mentioned earlier would leave most investors unimpressed.
Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 29% of total assets, this reported ROCE would probably be less than5.1% because total capital employed would be higher.The 5.1% ROCE could be even lower if current liabilities weren't 29% of total assets, because the the formula would show a larger base of total capital employed. With that in mind, just be wary if this ratio increases in the future, because if it gets particularly high, this brings with it some new elements of risk.
The Bottom Line On L.B. Foster's ROCE
Overall, we're not ecstatic to see L.B. Foster reducing the amount of capital it employs in the business. Since the stock has gained an impressive 54% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
If you'd like to know more about L.B. Foster, we've spotted 2 warning signs, and 1 of them is a bit unpleasant.
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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