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Persimmon Plc’s (LON:PSN) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

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It is hard to get excited after looking at Persimmon’s (LON:PSN) recent performance, when its stock has declined 15% over the past month. However, the company’s fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Persimmon’s ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Persimmon

How Is ROE Calculated?

ROE can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity

So, based on the above formula, the ROE for Persimmon is:

22% = UK£787m ÷ UK£3.6b (Based on the trailing twelve months to December 2021).

The ‘return’ is the yearly profit. So, this means that for every £1 of its shareholder’s investments, the company generates a profit of £0.22.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company’s future earnings. Depending on how much of these profits the company reinvests or “retains”, and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don’t necessarily bear these characteristics.

A Side By Side comparison of Persimmon’s Earnings Growth And 22% ROE

To begin with, Persimmon has a pretty high ROE which is interesting. Additionally, the company’s ROE is higher compared to the industry average of 11% which is quite remarkable. However, we are curious as to how the high returns still resulted in a flat growth for Persimmon in the past five years. So, there could be some other aspects that could potentially be preventing the company from growing. These include low earnings retention or poor allocation of capital

Next, on comparing with the industry net income growth, we found that the growth figure reported by Persimmon compares quite favourably to the industry average, which shows a decline of 7.8% in the same period.

past-earnings-growth
LSE:PSN Past Earnings Growth June 29th 2022

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock’s future looks promising or ominous. Is Persimmon fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Persimmon Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 95% (implying that the company keeps only 5.4% of its income) of its business to reinvest into its business), most of Persimmon’s profits are being paid to shareholders, which explains the absence of growth in earnings.

In addition, Persimmon has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts’ consensus data, we found that the company is expected to keep paying out approximately 96% of its profits over the next three years. Therefore, the company’s future ROE is also not expected to change by much with analysts predicting an ROE of 21%.

Summary

In total, it does look like Persimmon has some positive aspects to its business. Namely, its high earnings growth, which was likely due to its high ROE. However, investors could have benefitted even more from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining hardly any of its profits. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. Are these analysts expectations based on the broad expectations for the industry, or on the company’s fundamentals? Click here to be taken to our analyst’s forecasts page for the company.

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.

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