Today we are going to look at Lincoln Electric Holdings, Inc. (NASDAQ:LECO) to see whether it might be an attractive investment prospect. 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.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 Lincoln Electric Holdings:
0.22 = US$393m ÷ (US$2.4b - US$571m) (Based on the trailing twelve months to June 2019.)
Therefore, Lincoln Electric Holdings has an ROCE of 22%.
Is Lincoln Electric Holdings's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Lincoln Electric Holdings's ROCE appears to be substantially greater than the 12% average in the Machinery industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, Lincoln Electric Holdings's ROCE currently appears to be excellent.
You can see in the image below how Lincoln Electric Holdings's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Lincoln Electric Holdings.
What Are Current Liabilities, And How Do They Affect Lincoln Electric Holdings's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.
Lincoln Electric Holdings has total liabilities of US$571m and total assets of US$2.4b. As a result, its current liabilities are equal to approximately 24% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.
The Bottom Line On Lincoln Electric Holdings's ROCE
With low current liabilities and a high ROCE, Lincoln Electric Holdings could be worthy of further investigation. There might be better investments than Lincoln Electric Holdings out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.