Be Wary Of Southwest Airlines (NYSE:LUV) And Its Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Southwest Airlines (NYSE:LUV) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Southwest Airlines:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.013 = US$278m ÷ (US$34b - US$12b) (Based on the trailing twelve months to December 2024).

Thus, Southwest Airlines has an ROCE of 1.3%. Ultimately, that's a low return and it under-performs the Airlines industry average of 8.8%.

View our latest analysis for Southwest Airlines

In the above chart we have measured Southwest Airlines' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Southwest Airlines .

The Trend Of ROCE

The trend of ROCE doesn't look fantastic because it's fallen from 17% five years ago, while the business's capital employed increased by 27%. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. Southwest Airlines probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

What We Can Learn From Southwest Airlines' ROCE

Bringing it all together, while we're somewhat encouraged by Southwest Airlines' reinvestment in its own business, we're aware that returns are shrinking. And investors appear hesitant that the trends will pick up because the stock has fallen 44% in the last five years. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

If you'd like to know about the risks facing Southwest Airlines, we've discovered 2 warning signs that 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.

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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.