Yahoo Finance Is The Market Rewarding Persimmon Plc (LON:PSN) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?
With its stock down 11% over the past three months, it is easy to disregard Persimmon (LON:PSN). We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on Persimmon's ROE.
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.
Check out 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:
16% = UK£561m ÷ UK£3.4b (Based on the trailing twelve months to December 2022).
The 'return' is the profit over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.16 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
Persimmon's Earnings Growth And 16% ROE
To start with, Persimmon's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 10%. For this reason, Persimmon's five year net income decline of 5.1% raises the question as to why the high ROE didn't translate into earnings growth. We reckon that there could be some other factors at play here that are preventing the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
With the industry earnings declining at a rate of 4.5% in the same period, we deduce that both the company and the industry are shrinking at the same rate.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Persimmon fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Persimmon Efficiently Re-investing Its Profits?
Persimmon has a high three-year median payout ratio of 95% (that is, it is retaining 5.1% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. Our risks dashboard should have the 3 risks we have identified for Persimmon.
Moreover, Persimmon has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 58% over the next three years. However, Persimmon's future ROE is expected to decline to 11% despite the expected decline in its payout ratio. We infer that there could be other factors that could be steering the foreseen decline in the company's ROE.
Summary
In total, we're a bit ambivalent about Persimmon's performance. Despite the high ROE, the company has a disappointing earnings growth number, due to its poor rate of reinvestment into its business. That being so, the latest industry analyst forecasts show that analysts are forecasting a slight improvement in the company's future earnings growth. Sure enough, this could bring some relief to shareholders. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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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