Returns On Capital Signal Tricky Times Ahead For Lennox International (NYSE:LII)
If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So while Lennox International (NYSE:LII) has a high ROCE right now, lets see what we can decipher from how returns are changing.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Lennox International is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.37 = US$627m ÷ (US$2.6b - US$932m) (Based on the trailing twelve months to September 2022).
So, Lennox International has an ROCE of 37%. That's a fantastic return and not only that, it outpaces the average of 14% earned by companies in a similar industry.
View our latest analysis for Lennox International
Above you can see how the current ROCE for Lennox International compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at Lennox International doesn't inspire confidence. To be more specific, while the ROCE is still high, it's fallen from 47% where it was five years ago. 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.
On a related note, Lennox International has decreased its current liabilities to 35% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
What We Can Learn From Lennox International's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Lennox International is reinvesting for growth and has higher sales as a result. In light of this, the stock has only gained 25% over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.
Lennox International does come with some risks though, we found 3 warning signs in our investment analysis, and 2 of those are a bit concerning...
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here
