There Are Reasons To Feel Uneasy About Southwest Airlines' (NYSE:LUV) Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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)

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)

0.012 = US$310m ÷ (US$37b - US$12b) (Based on the trailing twelve months to September 2023).

Thus, Southwest Airlines has an ROCE of 1.2%. In absolute terms, that's a low return and it also under-performs the Airlines industry average of 9.3%.

Check out 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.

What Does the ROCE Trend For Southwest Airlines Tell Us?

When we looked at the ROCE trend at Southwest Airlines, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 1.2% from 16% five years ago. 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.

What We Can Learn From Southwest Airlines' ROCE

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. However, despite the promising trends, the stock has fallen 51% over the last five years, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One final note, you should learn about the 3 warning signs we've spotted with Southwest Airlines (including 1 which makes us a bit uncomfortable) .

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.