Today we are going to look at LyondellBasell Industries N.V. (NYSE:LYB) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.
How Do You Calculate Return On Capital Employed?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for LyondellBasell Industries:
0.23 = US$5.3b ÷ (US$28b – US$5.5b) (Based on the trailing twelve months to December 2018.)
So, LyondellBasell Industries has an ROCE of 23%.
Does LyondellBasell Industries Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In our analysis, LyondellBasell Industries’s ROCE is meaningfully higher than the 12% average in the Chemicals industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, LyondellBasell Industries’s ROCE is currently very good.
LyondellBasell Industries’s current ROCE of 23% is lower than its ROCE in the past, which was 33%, 3 years ago. Therefore we wonder if the company is facing new headwinds.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for LyondellBasell Industries.
Do LyondellBasell Industries’s Current Liabilities Skew Its ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.
LyondellBasell Industries has total liabilities of US$5.5b and total assets of US$28b. As a result, its current liabilities are equal to approximately 19% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
The Bottom Line On LyondellBasell Industries’s ROCE
This is good to see, and with such a high ROCE, LyondellBasell Industries may be worth a closer look. But note: LyondellBasell Industries may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.