Today we'll evaluate Lockheed Martin Corporation (NYSE:LMT) to determine whether it could have potential as an investment idea. 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. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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'.
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 Lockheed Martin:
0.24 = US$8.2b ÷ (US$49b - US$16b) (Based on the trailing twelve months to September 2019.)
So, Lockheed Martin has an ROCE of 24%.
Is Lockheed Martin's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Lockheed Martin's ROCE appears to be substantially greater than the 11% average in the Aerospace & Defense industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Lockheed Martin's ROCE in absolute terms currently looks quite high.
In our analysis, Lockheed Martin's ROCE appears to be 24%, compared to 3 years ago, when its ROCE was 15%. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how Lockheed Martin's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. 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 Lockheed Martin.
Do Lockheed Martin's Current Liabilities Skew Its ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Lockheed Martin has total liabilities of US$16b and total assets of US$49b. Therefore its current liabilities are equivalent to approximately 31% of its total assets. Lockheed Martin has a medium level of current liabilities, boosting its ROCE somewhat.
Our Take On Lockheed Martin's ROCE
Even so, it has a great ROCE, and could be an attractive prospect for further research. Lockheed Martin shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
I will like Lockheed Martin better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.