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It is hard to get excited after looking at Persimmon's (LON:PSN) recent performance, when its stock has declined 5.6% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Persimmon's ROE today.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for Persimmon
How Do You Calculate Return On Equity?
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£792m ÷ UK£3.6b (Based on the trailing twelve months to June 2021).
The 'return' is the amount earned after tax over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.22 in profit.
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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Persimmon's Earnings Growth And 22% ROE
First thing first, we like that Persimmon has an impressive ROE. Secondly, even when compared to the industry average of 12% the company's ROE is quite impressive. Yet, Persimmon has posted measly growth of 2.5% over the past five years. That's a bit unexpected from a company which has such a high rate of return. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
When you consider the fact that the industry earnings have shrunk at a rate of 6.8% in the same period, the company's net income growth is pretty remarkable.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is PSN fairly valued? This infographic on the company's intrinsic value has everything you need to know.