Today we’ll evaluate Allegiant Travel Company (NASDAQ:ALGT) 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, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
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. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
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 Allegiant Travel:
0.13 = US$291m ÷ (US$2.8b – US$595m) (Based on the trailing twelve months to June 2019.)
So, Allegiant Travel has an ROCE of 13%.
Is Allegiant Travel’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. It appears that Allegiant Travel’s ROCE is fairly close to the Airlines industry average of 12%. Independently of how Allegiant Travel compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Allegiant Travel’s current ROCE of 13% is lower than 3 years ago, when the company reported a 40% ROCE. Therefore we wonder if the company is facing new headwinds.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Allegiant Travel.
What Are Current Liabilities, And How Do They Affect Allegiant Travel’s ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Allegiant Travel has total liabilities of US$595m and total assets of US$2.8b. Therefore its current liabilities are equivalent to approximately 22% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Allegiant Travel’s ROCE
This is good to see, and with a sound ROCE, Allegiant Travel could be worth a closer look. There might be better investments than Allegiant Travel out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.