Shareholders Are Optimistic That Persimmon (LON:PSN) Will Multiply In Value

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. That's why when we briefly looked at Persimmon's (LON:PSN) ROCE trend, we were very happy with what we saw.

What Is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Persimmon:

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%. That's a fantastic return and not only that, it outpaces the average of 14% earned by companies in a similar industry.

View 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'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?

We'd be pretty happy with returns on capital like Persimmon. Over the past five years, ROCE has remained relatively flat at around 23% and the business has deployed 28% more capital into its operations. Now considering ROCE is an attractive 23%, 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.

One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 19% of total assets, is good to see from a business owner's perspective. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.

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. Yet over the last five years the stock has declined 33%, so the decline might provide an opening. For that reason, savvy investors might want to look further into this company in case it's a prime investment.

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.