To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we’d like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. And in light of that, the trends we’re seeing at Lennox International’s (NYSE:LII) look very promising so lets take a look.
Return On Capital Employed (ROCE): What is it?
Just to clarify if you’re unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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$434m ÷ (US$2.1b – US$946m) (Based on the trailing twelve months to June 2020).
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.
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.
How Are Returns Trending?
Lennox International has not disappointed with their ROCE growth. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 22% over the last five years. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. The company is doing well in that sense, and it’s worth investigating what the management team has planned for long term growth prospects.Another thing to note, Lennox International has a high ratio of current liabilities to total assets of 45%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we’d like to see this reduce as that would mean fewer obligations bearing risks.
The Bottom Line On Lennox International’s ROCE
To sum it up, Lennox International is collecting higher returns from the same amount of capital, and that’s impressive. Since the stock has returned a staggering 139% to shareholders over the last five years, it looks like investors are recognizing these changes. So given the stock has proven it has promising trends, it’s worth researching the company further to see if these trends are likely to persist.
If you’d like to know about the risks facing Lennox International, we’ve discovered 3 warning signs that you should be aware of.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
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