Investors Shouldn't Overlook The Favourable Returns On Capital At Persimmon (LON:PSN)

What trends should we look for it we want to identify stocks that can multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. That's why when we briefly looked at Persimmon's (LON:PSN) ROCE trend, we were very happy with what we saw.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its 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)

0.23 = 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 14%.

Check out our latest analysis for Persimmon

Above you can see how the current ROCE for Persimmon compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

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. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.

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 Bottom Line

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. However, despite the favorable fundamentals, the stock has fallen 20% over the last five years, so there might be an opportunity here for astute investors. That's why we think it'd be worthwhile to look further into this stock given the fundamentals are appealing.

Like most companies, Persimmon does come with some risks, and we've found 3 warning signs that you should be aware of.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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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.