Yahoo Finance Is The Market Rewarding Persimmon Plc (LON:PSN) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?
Persimmon (LON:PSN) has had a rough three months with its share price down 22%. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Specifically, we decided to study Persimmon's ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for Persimmon
How To Calculate Return On Equity?
ROE can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Persimmon is:
20% = UK£736m ÷ UK£3.6b (Based on the trailing twelve months to June 2022).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.20.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Persimmon's Earnings Growth And 20% ROE
To start with, Persimmon's ROE looks acceptable. Especially when compared to the industry average of 11% the company's ROE looks pretty impressive. However, we are curious as to how the high returns still resulted in flat growth for Persimmon in the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
We then compared Persimmon's performance with the industry and found that the company has shrunk its earnings at a slower rate than the industry earnings which has seen its earnings shrink by 4.9% in the same period. This does appease the negative sentiment around the company to a certain extent.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is PSN fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Persimmon Efficiently Re-investing Its Profits?
Persimmon has a high three-year median payout ratio of 95% (or a retention ratio of 5.4%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there's been no growth in its earnings.
Additionally, Persimmon has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 84% of its profits over the next three years. Regardless, Persimmon's ROE is speculated to decline to 13% despite there being no anticipated change in its payout ratio.
Summary
Overall, we have mixed feelings about Persimmon. Despite the high ROE, the company has a disappointing earnings growth number, due to its poor rate of reinvestment into its business. Additionally, the latest industry analyst forecasts show that analysts expect the company's earnings to continue to shrink in the future. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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.
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