If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Ergo, when we looked at the ROCE trends at Persimmon (LON:PSN), we liked 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. The formula for this calculation on Persimmon is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.21 = UK£785m ÷ (UK£4.6b - UK£875m) (Based on the trailing twelve months to December 2020).
So, Persimmon has an ROCE of 21%. In absolute terms that's a great return and it's even better than the Consumer Durables industry average of 6.8%.
See 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'd like to see what analysts are forecasting going forward, you should check out our free report for Persimmon.
How Are Returns Trending?
In terms of Persimmon's history of ROCE, it's quite impressive. The company has employed 30% more capital in the last five years, and the returns on that capital have remained stable at 21%. Now considering ROCE is an attractive 21%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.
Our Take On Persimmon's ROCE
In summary, we're delighted to see that Persimmon has been compounding returns by reinvesting at consistently high rates of return, as these are common traits of a multi-bagger. And long term investors would be thrilled with the 121% return they've received over the last five years. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.
One more thing to note, we've identified 1 warning sign with Persimmon and understanding it should be part of your investment process.
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. 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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About LSE:PSN
Flawless balance sheet and undervalued.
