Returns On Capital Signal Tricky Times Ahead For Southwest Airlines (NYSE:LUV)
Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. Having said that, from a first glance at Southwest Airlines (NYSE:LUV) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What Is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Southwest Airlines, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.04 = US$965m ÷ (US$36b - US$11b) (Based on the trailing twelve months to March 2023).
Therefore, Southwest Airlines has an ROCE of 4.0%. Ultimately, that's a low return and it under-performs the Airlines industry average of 7.4%.
Check out our latest analysis for Southwest Airlines
Above you can see how the current ROCE for Southwest Airlines compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Southwest Airlines.
What The Trend Of ROCE Can Tell Us
In terms of Southwest Airlines' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 18%, but since then they've fallen to 4.0%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
Our Take On Southwest Airlines' ROCE
While returns have fallen for Southwest Airlines in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And there could be an opportunity here if other metrics look good too, because the stock has declined 25% in the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.
On a final note, we found 2 warning signs for Southwest Airlines (1 is a bit concerning) you should be aware of.
While Southwest Airlines may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
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