Understanding Your Return On Investment In Air Canada (TSE:AC)

This analysis is intended to introduce important early concepts to people who are starting to invest and looking to gauge the potential return on investment in Air Canada (TSE:AC).

Purchasing Air Canada gives you an ownership stake in the company. Owing to this, it is important that the underlying business is producing a sufficient amount of income from the capital invested by stockholders. You need to pay attention to this because your return on investment is linked to dividends and internal investments to improve the business, which can only occur if the company is expected to produce adequate earnings with the capital that has been provided. To understand Air Canada’s capital returns we will look at a useful metric called return on capital employed. This will tell us if the company is growing your capital and placing you in good stead to sell your shares at a profit.

See our latest analysis for Air Canada

What is Return on Capital Employed (ROCE)?

As an investor you have many alternative companies to choose from, which means there is an opportunity cost in any investment you make in the form of a foregone investment in another company. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business' ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. To determine Air Canada's capital return we will use ROCE, which tells us how much the company makes from the capital employed in their operations (for things like machinery, wages etc). AC’s ROCE is calculated below:

As you can see, AC earned CA$7.9 from every CA$100 you invested over the previous twelve months. This shows Air Canada provides a dull capital return that is below the 15% ROCE that is typically considered to be a strong benchmark. Nevertheless, if AC is clever with their reinvestments or dividend payments, investors can still grow their capital but may fall behind other more attractive opportunities in the market.

What is causing this?

Air Canada's relatively poor ROCE is tied to the movement in two factors that change over time: earnings and capital requirements. At the moment Air Canada is in an adverse position, but this can change if these factors improve. Because of this, it is important to look beyond the final value of AC’s ROCE and understand what is happening to the individual components. Looking three years in the past, it is evident that AC's ROCE has risen from 1.72%, indicating the company's capital returns have stengthened. Over the same period, EBT went from CA$126.00m to CA$1.05b and capital employed improved as well albeit by a relatively smaller amount, signifying ROCE increased as a result of a greater surge in earnings compared to the business' use of capital.

Next Steps

ROCE for AC investors is below the desired level at the moment, however, the company has triggered an upward trend over the recent past which could signal an opportunity for a solid return on investment in the long term. It is important to know that ROCE does not dictate returns alone, so you need to consider other fundamentals in the business such as future prospects and valuation to determine if an opportunity exists that isn't made apparent by looking at past data. Air Canada's fundamentals can be explored with the links I've provided below if you are interested, otherwise you can start looking at other high-performing stocks.

1. Future Outlook: What are well-informed industry analysts predicting for AC’s future growth? Take a look at our free research report of analyst consensus for AC’s outlook.
2. Valuation: What is AC worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether AC is currently undervalued by the market.
3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

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.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article 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.