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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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at Forterra (LON:FORT), they do have a high ROCE, but we weren't exactly elated from how returns are trending.
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. Analysts use this formula to calculate it for Forterra:
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).
Therefore, 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
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, you can check out the forecasts from the analysts covering Forterra here for free.
The Trend Of ROCE
In terms of Forterra's historical ROCE movements, the trend isn't fantastic. While it's comforting that the ROCE is high, five years ago it was 28%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
The Bottom Line
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 19% over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.
If you want to continue researching Forterra, you might be interested to know about the 2 warning signs that our analysis has discovered.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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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.