Today we’ll look at Persimmon Plc (LON:PSN) and reflect on its potential as an investment. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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 Persimmon:
0.35 = UK£1.1b ÷ (UK£4.6b – UK£1.5b) (Based on the trailing twelve months to June 2019.)
Therefore, Persimmon has an ROCE of 35%.
Does Persimmon Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Persimmon’s ROCE is meaningfully higher than the 16% average in the Consumer Durables industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Persimmon’s ROCE currently appears to be excellent.
In our analysis, Persimmon’s ROCE appears to be 35%, compared to 3 years ago, when its ROCE was 25%. This makes us think the business might be improving. You can see in the image below how Persimmon’s ROCE compares to its industry. Click to see more on 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. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Persimmon’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Persimmon has total assets of UK£4.6b and current liabilities of UK£1.5b. As a result, its current liabilities are equal to approximately 32% of its total assets. Persimmon’s ROCE is boosted somewhat by its middling amount of current liabilities.
Our Take On Persimmon’s ROCE
Even so, it has a great ROCE, and could be an attractive prospect for further research. There might be better investments than Persimmon out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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