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

When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. So after glancing at the trends within Southwest Airlines (NYSE:LUV), we weren't too hopeful.

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What Is 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. 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)

0.027 = US$517m ÷ (US$33b - US$14b) (Based on the trailing twelve months to March 2025).

Therefore, Southwest Airlines has an ROCE of 2.7%. Ultimately, that's a low return and it under-performs the Airlines industry average of 9.0%.

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, you can check out the forecasts from the analysts covering Southwest Airlines for free.

What The Trend Of ROCE Can Tell Us

In terms of Southwest Airlines' historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 14%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Southwest Airlines to turn into a multi-bagger.

On a separate but related note, it's important to know that Southwest Airlines has a current liabilities to total assets ratio of 42%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line

In summary, it's unfortunate that Southwest Airlines is generating lower returns from the same amount of capital. Despite the concerning underlying trends, the stock has actually gained 16% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

Southwest Airlines does have some risks though, and we've spotted 1 warning sign for Southwest Airlines that you might be interested in.

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.