There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we’d want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So, when we ran our eye over Lennox International’s (NYSE:LII) trend of ROCE, we really liked what we saw.
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. Analysts use this formula to calculate it for Lennox International:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.37 = US$488m ÷ (US$2.0b – US$701m) (Based on the trailing twelve months to December 2020).
Therefore, Lennox International has an ROCE of 37%. In absolute terms that’s a great return and it’s even better than the Building industry average of 14%.
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’d like to see what analysts are forecasting going forward, you should check out our free report for Lennox International.
What Can We Tell From Lennox International’s ROCE Trend?
Lennox International deserves to be commended in regards to it’s returns. Over the past five years, ROCE has remained relatively flat at around 37% and the business has deployed 55% more capital into its operations. Now considering ROCE is an attractive 37%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns. You’ll see this when looking at well operated businesses or favorable business models.
One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 35% of total assets, is good to see from a business owner’s perspective. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.
Our Take On Lennox International’s ROCE
In the end, the company has proven it can reinvest it’s capital at high rates of returns, which you’ll remember is a trait of a multi-bagger. And the stock has done incredibly well with a 141% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
Lennox International does have some risks though, and we’ve spotted 2 warning signs for Lennox International that you might be interested in.
Lennox International is not the only stock earning high returns. If you’d like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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. 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.
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