LGI Homes, Inc. (NASDAQ:LGIH) Is Employing Capital Very Effectively
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Today we’ll look at LGI Homes, Inc. (NASDAQ:LGIH) and reflect on its potential as an investment. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.
So, How Do We Calculate ROCE?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for LGI Homes:
0.16 = US$170m ÷ (US$1.3b – US$94m) (Based on the trailing twelve months to September 2018.)
So, LGI Homes has an ROCE of 16%.
See our latest analysis for LGI Homes
Does LGI Homes Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that LGI Homes’s ROCE is meaningfully better than the 11% average in the Consumer Durables industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from LGI Homes’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for LGI Homes.
What Are Current Liabilities, And How Do They Affect LGI Homes’s ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
LGI Homes has total liabilities of US$94m and total assets of US$1.3b. Therefore its current liabilities are equivalent to approximately 7.0% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), LGI Homes earns a sound return on capital employed.
What We Can Learn From LGI Homes’s ROCE
If LGI Homes can continue reinvesting in its business, it could be an attractive prospect. You might be able to find a better buy than LGI Homes. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
