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What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at SkyWest (NASDAQ:SKYW) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Return On Capital Employed (ROCE): What is it?
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. The formula for this calculation on SkyWest is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.058 = US$334m ÷ (US$6.8b - US$986m) (Based on the trailing twelve months to June 2020).
So, SkyWest has an ROCE of 5.8%. Even though it's in line with the industry average of 5.8%, it's still a low return by itself.
In the above chart we have measured SkyWest's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering SkyWest here for free.
What The Trend Of ROCE Can Tell Us
In terms of SkyWest's historical ROCE trend, it doesn't exactly demand attention. The company has employed 41% more capital in the last five years, and the returns on that capital have remained stable at 5.8%. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
Long story short, while SkyWest has been reinvesting its capital, the returns that it's generating haven't increased. Although the market must be expecting these trends to improve because the stock has gained 84% over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
SkyWest does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is a bit unpleasant...
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
This article by Simply Wall St is general in nature. 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.
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