Here's What's Concerning About Parsons' (NYSE:PSN) Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at Parsons (NYSE:PSN) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Parsons:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.065 = US$204m ÷ (US$4.3b - US$1.1b) (Based on the trailing twelve months to March 2023).

So, Parsons has an ROCE of 6.5%. In absolute terms, that's a low return and it also under-performs the Aerospace & Defense industry average of 9.9%.

View our latest analysis for Parsons

In the above chart we have measured Parsons' 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.

How Are Returns Trending?

When we looked at the ROCE trend at Parsons, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 6.5% from 9.4% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Parsons has done well to pay down its current liabilities to 27% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Parsons' ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Parsons. And the stock has followed suit returning a meaningful 35% to shareholders over the last three years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

While Parsons doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.

While Parsons may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list 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.