Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, the ROCE of Lowe's Companies (NYSE:LOW) looks attractive right now, so lets see what the trend of returns can tell us.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Lowe's Companies:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.29 = US$8.7b ÷ (US$52b - US$21b) (Based on the trailing twelve months to July 2020).
So, Lowe's Companies has an ROCE of 29%. That's a fantastic return and not only that, it outpaces the average of 9.7% earned by companies in a similar industry.
Above you can see how the current ROCE for Lowe's Companies compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Lowe's Companies here for free.
How Are Returns Trending?
Lowe's Companies deserves to be commended in regards to it's returns. The company has employed 47% more capital in the last five years, and the returns on that capital have remained stable at 29%. Now considering ROCE is an attractive 29%, 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, Lowe's Companies' current liabilities are still rather high at 41% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
Our Take On Lowe's Companies' ROCE
Lowe's Companies has demonstrated its proficiency by generating high returns on increasing amounts of capital employed, which we're thrilled about. And the stock has done incredibly well with a 156% return over the last five years, so long term investors are no doubt ecstatic with that result. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.
On a separate note, we've found 2 warning signs for Lowe's Companies you'll probably want to know about.
Lowe's Companies is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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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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