The Returns On Capital At Persimmon (LON:PSN) Don't Inspire Confidence

What underlying fundamental trends can indicate that a company might be in decline? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after glancing at the trends within Persimmon (LON:PSN), we weren't too hopeful.

Understanding Return On Capital Employed (ROCE)

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)

0.18 = UK£722m ÷ (UK£5.0b - UK£1.1b) (Based on the trailing twelve months to December 2022).

Thus, Persimmon has an ROCE of 18%. In absolute terms, that's a satisfactory return, but compared to the Consumer Durables industry average of 13% it's much better.

View 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, you can check out the forecasts from the analysts covering Persimmon here for free.

The Trend Of ROCE

In terms of Persimmon's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 27%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Persimmon becoming one if things continue as they have.

The Bottom Line On Persimmon's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Long term shareholders who've owned the stock over the last five years have experienced a 31% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Persimmon does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those doesn't sit too well with us...

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.