This analysis is intended to introduce important early concepts to people who are starting to invest and want to better understand how you can grow your money by investing in Leonardo Spa (BIT:LDO).
Buying Leonardo makes you a partial owner of the company. Owing to this, it is important that the underlying business is producing a sufficient amount of income from the capital invested by stockholders. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. Thus, to understand how your money can grow by investing in Leonardo, you need to look at what the company returns to owners for the use of their capital, which can be done in many ways but today we will use return on capital employed (ROCE).
What is Return on Capital Employed (ROCE)?
As an investor you have many alternative companies to choose from, which means there is an opportunity cost in any investment you make in the form of a foregone investment in another company. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. We’ll look at Leonardo’s returns by computing return on capital employed, which will tell us what the company can generate from the money spent in operations. I have calculated Leonardo’s ROCE for you below:
ROCE Calculation for LDO
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = €604.00m ÷ (€23.20b – €13.06b) = 5.95%
The calculation above shows that LDO’s earnings were 5.95% of capital employed. Comparing this to a healthy 15% benchmark shows Leonardo is currently unable to return a satisfactory amount to owners for the use of their capital, which isn’t good for investors who have forgone other potentially solid companies.
Then why have investors invested?
Although Leonardo is in an unfavourable position, you should know that this could change if the company is able to increase earnings on the same capital base or find new efficiencies that require less capital to produce earnings. Because of this, it is important to look beyond the final value of LDO’s ROCE and understand what is happening to the individual components. Three years ago, LDO’s ROCE was 3.70%, which means the company’s capital returns have improved. Similarly, the movement in the earnings variable shows a jump from €468.00m to €604.00m whilst the amount of capital employed has decreased in response to a decreased level of total assets , which means that ROCE has increased as a result of Leonardo’s ability to grow earnings in conjunction with increased capital efficiency.
Despite LDO’s current ROCE remains at an unattractive level, the company has triggered an upward trend over the recent past which could signal an opportunity for a solid return on investment in the long term. But don’t forget, return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like future prospects and valuation to determine whether there is potential for return by focusing our attention elsewhere. If you’re building your portfolio and want to take a deeper look, I’ve added a few links below that will help you further evaluate LDO or move on to other alternatives.
- Future Outlook: What are well-informed industry analysts predicting for LDO’s future growth? Take a look at our free research report of analyst consensus for LDO’s outlook.
- Valuation: What is LDO worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether LDO is currently undervalued by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.