Southwest Airlines (NYSE:LUV) May Have Issues Allocating Its Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Southwest Airlines (NYSE:LUV) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding 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)

0.064 = US$1.6b ÷ (US$36b - US$10b) (Based on the trailing twelve months to September 2022).

So, Southwest Airlines has an ROCE of 6.4%. Even though it's in line with the industry average of 6.1%, it's still a low return by itself.

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 20%, but since then they've fallen to 6.4%. 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.

In Conclusion...

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. And there could be an opportunity here if other metrics look good too, because the stock has declined 43% 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 separate note, we've found 1 warning sign for Southwest Airlines you'll probably want to know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.