Lennox International (NYSE:LII) Knows How To Allocate Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. Ergo, when we looked at the ROCE trends at Lennox International (NYSE:LII), we liked what we saw.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the 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)

0.43 = US$904m ÷ (US$3.2b - US$1.1b) (Based on the trailing twelve months to June 2024).

So, Lennox International has an ROCE of 43%. In absolute terms that's a great return and it's even better than the Building industry average of 16%.

See our latest analysis for Lennox International

In the above chart we have measured Lennox International's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Lennox International for free.

What The Trend Of ROCE Can Tell Us

In terms of Lennox International's history of ROCE, it's quite impressive. The company has employed 67% more capital in the last five years, and the returns on that capital have remained stable at 43%. Now considering ROCE is an attractive 43%, 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.

On a side note, Lennox International has done well to reduce current liabilities to 34% of total assets over the last five years. Effectively suppliers now fund less of the business, which can lower some elements of risk.

The Bottom Line

In summary, we're delighted to see that Lennox International has been compounding returns by reinvesting at consistently high rates of return, as these are common traits of a multi-bagger. And the stock has done incredibly well with a 172% return over the last five years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.

If you'd like to know about the risks facing Lennox International, we've discovered 2 warning signs that you should be aware of.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.