The Returns On Capital At Parsons (NYSE:PSN) Don't Inspire Confidence

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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Parsons (NYSE:PSN) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. The formula for this calculation on Parsons is:

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

0.044 = US$132m ÷ (US$4.1b - US$1.1b) (Based on the trailing twelve months to June 2022).

Therefore, Parsons has an ROCE of 4.4%. In absolute terms, that's a low return and it also under-performs the Aerospace & Defense industry average of 8.8%.

Check out 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'd like, you can check out the forecasts from the analysts covering Parsons here for free.

How Are Returns Trending?

In terms of Parsons' historical ROCE movements, the trend isn't fantastic. Around four years ago the returns on capital were 9.9%, but since then they've fallen to 4.4%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Parsons has decreased its current liabilities to 27% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

Our Take On Parsons' ROCE

To conclude, we've found that Parsons is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 24% over the last three years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Parsons could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.

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.