Will Leonardo's (BIT:LDO) Growth In ROCE Persist?

There are a few key trends to look for if we want to identify the next multi-bagger. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Leonardo's (BIT:LDO) returns on capital, so let's have 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. To calculate this metric for Leonardo, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.092 = €1.1b ÷ (€18b - €6.4b) (Based on the trailing twelve months to March 2020).

Thus, Leonardo has an ROCE of 9.2%. On its own, that's a low figure but it's around the 9.9% average generated by the Aerospace & Defense industry.

View our latest analysis for Leonardo

In the above chart we have a measured Leonardo's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Leonardo.

What The Trend Of ROCE Can Tell Us

Leonardo has not disappointed with their ROCE growth. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 54% in that same time. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.

On a related note, the company's ratio of current liabilities to total assets has decreased to 36%, which basically reduces it's funding from the likes of short-term creditors or suppliers. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.

The Bottom Line

As discussed above, Leonardo appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Given the stock has declined 55% in the last five years, there could be a chance of a good investment here if the valuation makes sense. With that in mind, we believe the promising trends warrant this stock for further investigation.

Leonardo does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those shouldn't be ignored...

While Leonardo isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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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