What trends should we look for it we want to identify stocks that can multiply in value over the long term? In a perfect world, we’d like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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.
Understanding Return On Capital Employed (ROCE)
For those who don’t know, ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Southwest Airlines is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.048 = US $ 1.3b ÷ (US $ 38b – US $ 12b) (Based on the trailing twelve months to June 2022).
I know, Southwest Airlines has an ROCE of 4.8%. Even though it’s in line with the industry average of 4.8%, it’s still a low return by itself.
See 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’re interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Can We Tell From Southwest Airlines’ ROCE Trend?
On the surface, the trend of ROCE at Southwest Airlines doesn’t inspire confidence. Around five years ago the returns on capital were 22%, but since then they’ve fallen to 4.8%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
What We Can Learn From Southwest Airlines’ ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Southwest Airlines. However, despite the promising trends, the stock has fallen 26% over the last five years, so there might be an opportunity here for astute investors. So we think it’d be worthwhile to look further into this stock given the trends look encouraging.
If you’d like to know about the risks facing Southwest Airlines, we’ve discovered 1 warning sign that you should be aware of.
While Southwest Airlines isn’t earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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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