Persimmon (LON:PSN) has had a tough three months, with its share price down 5.3%. To determine whether this trend continues, we decided to focus on the weakness in the fundamentals that shape long-term market trends. This time, I decided to focus on Persimmon's ROE.
Return on equity or ROE is an important factor to be considered by a shareholder as it indicates how effectively their capital is being reinvested. In other words, it is a profitability ratio that measures the rate of return on the capital provided by a company's shareholders.
Check out our latest analysis for Persimmon.
How is ROE calculated?
Return on equity can be calculated using the following formula:
Return on equity = Net income (from continuing operations) ÷ Shareholders' equity
So, based on the above formula, Persimmon's ROE is:
7.5% = GBP 255 million ÷ GBP 3.4 billion (based on the trailing twelve months to December 2023).
“Return” refers to a company's earnings over the past year. Another way to think of it is that for every £1 worth of shares, the company could earn him £0.07 in profit.
What relationship does ROE have with profit growth?
So far, we have learned that ROE is a measure of a company's profitability. Depending on how much of these profits a company reinvests or “retains”, and how effectively it does so, we are then able to assess a company's earnings growth potential. Assuming all else is equal, companies with both higher return on equity and higher profit retention typically have higher growth rates when compared to companies that don't have the same characteristics.
Persimmon's earnings growth and ROE 7.5%
At first glance, Persimmon's ROE isn't much to talk about. However, upon closer inspection, we find that his ROE for the company is comparable to the industry average of his 7.6%. However, Persimmon's net income has declined by 16% over the past five years. Don't forget that the company's ROE is a bit low to begin with. That may be causing the profit growth rate to shrink.
Furthermore, we find that Persimmon's performance is quite disappointing, even when compared to its industry, which has seen its earnings shrink at a rate of 3.6% over the past few years. This is because it suggests that the company is shrinking its earnings at a certain rate. Faster than the industry.
Earnings growth is a big factor in stock valuation. It's important for investors to know whether the market is pricing in a company's expected earnings growth (or decline). This can help you decide whether to position the stock for a bright or bleak future. Is PSN fairly valued? This infographic on the company's intrinsic value contains everything you need to know.
Is Kaki effectively using its profits?
Persimmon's declining earnings are not surprising, given that the company spends most of its profits on dividends, based on its three-year median payout ratio of 95% (or retention rate of 4.8%). The business is left with only a small amount of capital that can be reinvested. This is a vicious cycle that does not benefit the company in the long run. The risks dashboard should now show the two risks he has identified regarding Persimmon.
Additionally, Persimmon has been paying dividends for at least 10 years, suggesting that maintaining the dividend is far more important to management, even if it comes at the expense of business growth. After researching the latest analyst consensus data, we find that the company's future dividend payout ratio is expected to decline to 57% over the next three years. As a result, the expected decline in Persimmon's dividend payout ratio explains that the company's future ROE over the same period is expected to rise to his 12%.
summary
Overall, Persimmon's performance is pretty disappointing. The low ROE, combined with the fact that the company pays out most, if not all, of its profits in dividends has resulted in little or no earnings growth. Having said that, we researched the latest analyst forecasts and found that while the company has seen its earnings shrink in the past, analysts expect its future earnings to grow. Learn more about the company's future revenue growth forecasts here. free Create a report on analyst forecasts to learn more about a company.
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This article by Simply Wall St is general in nature. We provide commentary using only unbiased methodologies, based on historical data and analyst forecasts, and articles are not intended to be financial advice. This is not a recommendation to buy or sell any stock, and does not take into account your objectives or financial situation. We aim to provide long-term, focused analysis based on fundamental data. Note that our analysis may not factor in the latest announcements or qualitative material from price-sensitive companies. Simply Wall St has no position in any stocks mentioned.
