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What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Looking at Forterra (LON:FORT), it does have a high ROCE right now, but lets see how returns are trending.
Understanding 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. The formula for this calculation on Forterra is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.25 = UK£61m ÷ (UK£329m - UK£85m) (Based on the trailing twelve months to December 2019).
So, Forterra has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Basic Materials industry average of 13%.
See our latest analysis for Forterra
Above you can see how the current ROCE for Forterra 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 Forterra.
How Are Returns Trending?
Over the past three years, Forterra's ROCE and capital employed have both remained mostly flat. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. So while the current operations are delivering respectable returns, unless capital employed increases we'd be hard-pressed to believe it's a multi-bagger going forward. With fewer investment opportunities, it makes sense that Forterra has been paying out a decent 42% of its earnings to shareholders. Given the business isn't reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.
The Key Takeaway
Although is allocating it's capital efficiently to generate impressive returns, it isn't compounding its base of capital, which is what we'd see from a multi-bagger. And in the last three years, the stock has given away 38% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think Forterra has the makings of a multi-bagger.