Today we’ll evaluate Air Lease Corporation (NYSE:AL) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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’.

So, How Do We Calculate ROCE?

The formula for calculating the return on capital employed is:

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

Or for Air Lease:

0.055 = US$897m ÷ (US$18b – US$310m) (Based on the trailing twelve months to September 2018.)

Therefore, Air Lease has an ROCE of 5.5%.

Check out our latest analysis for Air Lease

Want to help shape the future of investing tools and platforms? Take the survey and be part of one of the most advanced studies of stock market investors to date.

Does Air Lease Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Air Lease’s ROCE appears to be significantly below the 7.9% average in the Trade Distributors industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Air Lease compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. Readers may wish to look for more rewarding investments.

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do Air Lease’s Current Liabilities Skew Its ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Air Lease has total assets of US$18b and current liabilities of US$310m. As a result, its current liabilities are equal to approximately 1.8% of its total assets. Air Lease has very few current liabilities, which have a minimal effect on its already low ROCE.

What We Can Learn From Air Lease’s ROCE

Nonetheless, there may be better places to invest your capital. You might be able to find a better buy than Air Lease. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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 editorial-team@simplywallst.com.