Returns On Capital Signal Difficult Times Ahead For Persimmon (LON:PSN)

What financial metrics can indicate to us that a company is maturing or even in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after we looked into Persimmon (LON:PSN), the trends above didn't look too great.

Return On Capital Employed (ROCE): What Is It?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Persimmon, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.16 = UK£625m ÷ (UK£4.8b - UK£949m) (Based on the trailing twelve months to December 2023).

So, Persimmon has an ROCE of 16%. In absolute terms, that's a satisfactory return, but compared to the Consumer Durables industry average of 9.3% it's much better.

View our latest analysis for Persimmon

roce

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, you can check out the forecasts from the analysts covering Persimmon for free.

So How Is Persimmon's ROCE Trending?

There is reason to be cautious about Persimmon, given the returns are trending downwards. About five years ago, returns on capital were 31%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Persimmon becoming one if things continue as they have.

The Bottom Line

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Investors haven't taken kindly to these developments, since the stock has declined 24% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing to note, we've identified 3 warning signs with Persimmon and understanding these should be part of your investment process.

While Persimmon isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.