Did Persimmon plc (LON:PSN) Create Value For Shareholders?
Persimmon plc (LSE:PSN) delivered an ROE of 28.13% over the past 12 months, which is an impressive feat relative to its industry average of 15.85% during the same period. While the impressive ratio tells us that PSN has made significant profits from little equity capital, ROE doesn’t tell us if PSN has borrowed debt to make this happen. In this article, we’ll closely examine some factors like financial leverage to evaluate the sustainability of PSN’s ROE. View our latest analysis for Persimmon
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Persimmon’s profit relative to its shareholders’ equity. For example, if the company invests £1 in the form of equity, it will generate £0.28 in earnings from this. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of Persimmon’s equity capital deployed. Its cost of equity is 8.30%. Given a positive discrepancy of 19.83% between return and cost, this indicates that Persimmon pays less for its capital than what it generates in return, which is a sign of capital efficiency. ROE can be dissected into three distinct ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
Dupont Formula
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover shows how much revenue Persimmon can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since financial leverage can artificially inflate ROE, we need to look at how much debt Persimmon currently has. Currently, Persimmon has no debt which means its returns are driven purely by equity capital. Therefore, the level of financial leverage has no impact on ROE, and the ratio is a representative measure of the efficiency of all its capital employed firm-wide.
What this means for you:
Are you a shareholder? PSN’s ROE is impressive relative to the industry average and also covers its cost of equity. Since its high ROE is not likely driven by high debt, it might be a good time to top up on your current holdings if your fundamental research reaffirms this analysis. If you’re looking for new ideas for high-returning stocks, you should take a look at our free platform to see the list of stocks with Return on Equity over 20%.
Are you a potential investor? If you are considering investing in PSN, looking at ROE on its own is not enough to make a well-informed decision. I recommend you do additional fundamental analysis by looking through our most recent infographic report on Persimmon to help you make a more informed investment decision.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
