Return on invested capital (or ROIC), which is a profitability ratio, measures the return that an investment generates over total invested capital, including debt. ROIC is a better measure of efficiency than ROE (return on equity) because it removes the debt-related distortion that can make highly leveraged companies look very profitable when using ROE.
Toll Brothers has the lowest ROIC
Most of the major homebuilders reported negative ROIC from 2006–2011, and Toll Brothers (TOL) is no exception. As the economy began to recover in 2012, ROIC also improved for most of the players. During the last five years, Toll Brothers’ (TOL) ROIC ranged from -14.2%–9.6%.
The current data show that Toll Brothers (TOL) has an ROIC of 4.3%, the lowest in its peer group. On the other hand, KB Home (KBH), PulteGroup (PHM), Lennar (LEN), and D.R. Horton (DHI) recorded much higher ROICs, at 23.8%, 8.1%, 6.8%, and 6.5%, respectively.
ROE is a profitability ratio that measures the ability of a comopany to generate profits from its shareholders’ investments in the company. In other words, the ROE ratio shows how much profit each dollar of common stockholders’ equity generates.
ROE is an important indicator for potential investors, because they want to see how efficiently a company will use its money to generate net income.
Peer group ROE
Toll Brothers (TOL) has the lowest ROE in its peer group at 8.8%. Its major competitors—KB Home (KBH), D.R. Horton (DHI), Lennar (LEN), and PulteGroup (PHM)—have all reported higher ROEs of 77%, 12.8%, 15.1%, and 11.1%, respectively.
Investors looking for diversification in the homebuilding sector can consider ETFs like the SPDR S&P Homebuilders ETF (XHB) and the iShares US Home Construction ETF (ITB). Toll Brothers (TOL) forms 7.78% of the holdings of the iShares US Home Construction ETF (ITB).
In the next part of our series, we’ll analyze Toll Brothers’ valuation.