Today we are going to look at SkyWest, Inc. (NASDAQ:SKYW) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
How Do You Calculate Return On Capital Employed?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for SkyWest:
0.09 = US$504m ÷ (US$6.5b - US$945m) (Based on the trailing twelve months to March 2019.)
So, SkyWest has an ROCE of 9.0%.
Does SkyWest Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see SkyWest's ROCE is meaningfully below the Airlines industry average of 12%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how SkyWest stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
In our analysis, SkyWest's ROCE appears to be 9.0%, compared to 3 years ago, when its ROCE was 6.4%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how SkyWest's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for SkyWest.
What Are Current Liabilities, And How Do They Affect SkyWest's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
SkyWest has total assets of US$6.5b and current liabilities of US$945m. Therefore its current liabilities are equivalent to approximately 14% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
Our Take On SkyWest's ROCE
If SkyWest continues to earn an uninspiring ROCE, there may be better places to invest. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.