BAE Systems plc's (LON:BA.) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

BAE Systems (LON:BA.) has had a rough month with its share price down 11%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on BAE Systems' ROE.

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 BAE Systems

How Is ROE Calculated?

Return on equity 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 BAE Systems is:

17% = UK£1.9b ÷ UK£11b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.17 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

BAE Systems' Earnings Growth And 17% ROE

At first glance, BAE Systems seems to have a decent ROE. Even when compared to the industry average of 14% the company's ROE looks quite decent. This certainly adds some context to BAE Systems' moderate 7.6% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that BAE Systems' reported growth was lower than the industry growth of 16% over the last few years, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is BA. fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is BAE Systems Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 49% (implying that the company retains 51% of its profits), it seems that BAE Systems is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, BAE Systems has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 45%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 18%.

Conclusion

Overall, we are quite pleased with BAE Systems' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.