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

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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. 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.

Return On Capital Employed (ROCE): What Is It?

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

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

0.076 = US$245m ÷ (US$4.5b - US$1.3b) (Based on the trailing twelve months to June 2023).

Thus, Parsons has an ROCE of 7.6%. Ultimately, that's a low return and it under-performs the Aerospace & Defense industry average of 9.5%.

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.

What The Trend Of ROCE Can Tell Us

In terms of Parsons' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 9.9% over the last five years. 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 related note, Parsons has decreased its current liabilities to 29% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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.

What We Can Learn From 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 66% to shareholders over the last three years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

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.