Does Forterra plc's (LON:FORT) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

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editorial-team@simplywallst.com (Simply Wall St)

Mon, Aug 19, 2024, 11:03 PM 4 min read

Forterra (LON:FORT) has had a great run on the share market with its stock up by a significant 5.8% over the last week. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. Particularly, we will be paying attention to Forterra's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Forterra

How Do You Calculate Return On Equity?

ROE can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Forterra is:

3.7% = UK£8.0m ÷ UK£218m (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £0.04 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Forterra's Earnings Growth And 3.7% ROE

It is quite clear that Forterra's ROE is rather low. Even when compared to the industry average of 6.4%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 2.5% seen by Forterra was possibly a result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

So, as a next step, we compared Forterra's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 9.0% over the last few years.

past-earnings-growth — LSE:FORT Past Earnings Growth August 20th 2024

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is FORT fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Forterra Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 54% (implying that 46% of the profits are retained), most of Forterra's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 3 risks we have identified for Forterra by visiting our risks dashboard for free on our platform here.

Moreover, Forterra has been paying dividends for eight years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 50% of its profits over the next three years. Still, forecasts suggest that Forterra's future ROE will rise to 12% even though the the company's payout ratio is not expected to change by much.

Conclusion

On the whole, Forterra's performance is quite a big let-down. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.