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

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after investigating Persimmon (LON:PSN), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed 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)

0.095 = UK£355m ÷ (UK£4.8b - UK£1.1b) (Based on the trailing twelve months to June 2024).

So, Persimmon has an ROCE of 9.5%. Even though it's in line with the industry average of 8.7%, it's still a low return by itself.

See our latest analysis for Persimmon

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.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Persimmon, we didn't gain much confidence. Around five years ago the returns on capital were 35%, but since then they've fallen to 9.5%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

Our Take On Persimmon's ROCE

In summary, we're somewhat concerned by Persimmon's diminishing returns on increasing amounts of capital. It should come as no surprise then that the stock has fallen 42% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

On a separate note, we've found 1 warning sign for Persimmon you'll probably want to know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.