Persimmon Plc's (LON:PSN) Dismal Stock Performance Reflects Weak Fundamentals

With its stock down 27% over the past three months, it is easy to disregard Persimmon (LON:PSN). Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. Particularly, we will be paying attention to Persimmon's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Persimmon

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Persimmon is:

7.5% = UK£256m ÷ UK£3.4b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.08 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Persimmon's Earnings Growth And 7.5% ROE

At first glance, Persimmon's ROE doesn't look very promising. However, the fact that the its ROE is quite higher to the industry average of 6.0% doesn't go unnoticed by us. But seeing Persimmon's five year net income decline of 20% over the past five years, we might rethink that. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. Therefore, the decline in earnings could also be the result of this.

As a next step, we compared Persimmon's performance with the industry and found thatPersimmon's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 0.4% in the same period, which is a slower than the company.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. What is PSN worth today? The intrinsic value infographic in our free research report helps visualize whether PSN is currently mispriced by the market.

Is Persimmon Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 95% (implying that 5.4% of the profits are retained), most of Persimmon's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.

Moreover, Persimmon has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 57% over the next three years. The fact that the company's ROE is expected to rise to 12% over the same period is explained by the drop in the payout ratio.

Summary

On the whole, Persimmon's performance is quite a big let-down. The company has shown a disappointing growth in its earnings as a result of it retaining little to almost none of its profits. So, the decent ROE it does have, is not much useful to investors given that the company is reinvesting very little into its business. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.