Pennant Group's (NASDAQ:PNTG) Returns On Capital Not Reflecting Well On The Business
What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Pennant Group (NASDAQ:PNTG), we don't think it's current trends fit the mold of a multi-bagger.
What is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Pennant Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.049 = US$21m ÷ (US$507m - US$89m) (Based on the trailing twelve months to December 2020).
Thus, Pennant Group has an ROCE of 4.9%. In absolute terms, that's a low return and it also under-performs the Healthcare industry average of 11%.
Check out our latest analysis for Pennant Group
Above you can see how the current ROCE for Pennant Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Does the ROCE Trend For Pennant Group Tell Us?
In terms of Pennant Group's historical ROCE movements, the trend isn't fantastic. Over the last three years, returns on capital have decreased to 4.9% from 25% three years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
On a side note, Pennant Group has done well to pay down its current liabilities to 18% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
What We Can Learn From Pennant Group's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Pennant Group is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 176% to shareholders in the last year. 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.
One more thing, we've spotted 1 warning sign facing Pennant Group that you might find interesting.
While Pennant Group may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
This article by Simply Wall St is general in nature. 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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