Will Weakness in Rheinmetall AG's (ETR:RHM) Stock Prove Temporary Given Strong Fundamentals?

With its stock down 8.9% over the past month, it is easy to disregard Rheinmetall (ETR:RHM). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Rheinmetall's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Rheinmetall

How Do You Calculate Return On Equity?

The formula for return on equity is:

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

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

20% = €711m ÷ €3.6b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.20 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.

A Side By Side comparison of Rheinmetall's Earnings Growth And 20% ROE

To begin with, Rheinmetall seems to have a respectable ROE. Especially when compared to the industry average of 13% the company's ROE looks pretty impressive. Probably as a result of this, Rheinmetall was able to see a decent growth of 16% over the last five years.

We then performed a comparison between Rheinmetall's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 17% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Rheinmetall fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Rheinmetall Making Efficient Use Of Its Profits?

Rheinmetall has a three-year median payout ratio of 37%, which implies that it retains the remaining 63% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Moreover, Rheinmetall is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 34% of its profits over the next three years. However, Rheinmetall's ROE is predicted to rise to 30% despite there being no anticipated change in its payout ratio.

Conclusion

Overall, we are quite pleased with Rheinmetall's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.

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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.