Today we'll look at Lennox International Inc. (NYSE:LII) 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.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.'
How Do You Calculate Return On Capital Employed?
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 Lennox International:
0.61 = US$494m ÷ (US$1.8b - US$1.0b) (Based on the trailing twelve months to December 2018.)
So, Lennox International has an ROCE of 61%.
Does Lennox International Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Lennox International's ROCE is meaningfully higher than the 15% average in the Building industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, Lennox International's ROCE is currently very good.
Our data shows that Lennox International currently has an ROCE of 61%, compared to its ROCE of 42% 3 years ago. This makes us wonder if the company is improving.
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, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Lennox International.
Do Lennox International's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Lennox International has total liabilities of US$1.0b and total assets of US$1.8b. Therefore its current liabilities are equivalent to approximately 55% of its total assets. While a high level of current liabilities boosts its ROCE, Lennox International's returns are still very good.
What We Can Learn From Lennox International's ROCE
So we would be interested in doing more research here -- there may be an opportunity! Lennox International looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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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.