Southwest Airlines' (NYSE:LUV) Returns On Capital Not Reflecting Well On The Business

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. 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)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from 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)

0.024 = US$602m ÷ (US$37b - US$12b) (Based on the trailing twelve months to June 2023).

Thus, Southwest Airlines has an ROCE of 2.4%. In absolute terms, that's a low return and it also under-performs the Airlines industry average of 9.7%.

See 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'd like to see what analysts are forecasting going forward, you should check out our free report for Southwest Airlines.

The Trend Of ROCE

On the surface, the trend of ROCE at Southwest Airlines doesn't inspire confidence. Around five years ago the returns on capital were 17%, but since then they've fallen to 2.4%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

The Key Takeaway

While returns have fallen for Southwest Airlines in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These growth trends haven't led to growth returns though, since the stock has fallen 42% over the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Southwest Airlines does have some risks, we noticed 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.