Yahoo Finance Persimmon (LON:PSN) Knows How To Allocate Capital
What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So, when we ran our eye over Persimmon's (LON:PSN) trend of ROCE, we really liked what we saw.
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. Analysts use this formula to calculate it for Persimmon:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.23 = UK£917m ÷ (UK£4.9b - UK£939m) (Based on the trailing twelve months to June 2022).
Therefore, Persimmon has an ROCE of 23%. In absolute terms that's a great return and it's even better than the Consumer Durables industry average of 12%.
View our latest analysis for Persimmon
In the above chart we have measured Persimmon's 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 Persimmon.
So How Is Persimmon's ROCE Trending?
Persimmon deserves to be commended in regards to it's returns. The company has employed 28% more capital in the last five years, and the returns on that capital have remained stable at 23%. With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return. You'll see this when looking at well operated businesses or favorable business models.
On a side note, Persimmon has done well to reduce current liabilities to 19% of total assets over the last five years. Effectively suppliers now fund less of the business, which can lower some elements of risk.
The Key Takeaway
In the end, the company has proven it can reinvest it's capital at high rates of returns, which you'll remember is a trait of a multi-bagger. Yet over the last five years the stock has declined 26%, so the decline might provide an opening. For that reason, savvy investors might want to look further into this company in case it's a prime investment.
One more thing to note, we've identified 3 warning signs with Persimmon and understanding them should be part of your investment process.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
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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